WINNERS IN THE AGE OF THE TITANS

TABLE OF CONTENTS

PREFACE NOTES TO THE READER EXECUTIVE SUMMARY I. THE STATE OF THE BANKING INDUSTRY Business Confidence Improved Substantially Growth and Consolidation Reappeared on the Agenda Investment Banking Outperformed Other Segments Strong Performance Existed Across Countries II. THE PATH TO VALUE CREATION Stock Market Stars Profitability and Growth Stars Selected Success Stories III. RANKINGS OF TOP PERFORMERS Large-Cap Companies Mid-Cap Companies Segment Ranking Country Ranking APPENDIX: SAMPLE AND METHODOLOGY Sample and Data Definitions and Methodology

3 4 5 6 6 8 10 13 16 16 17 19 23 23 24 25 26 27 27 27

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PREFACE
Banking is changing rapidly as the industry consolidates and financial markets become more global and competitive. We believe that financial executives should focus rigorously on creating value improving profitability and growthif their companies are to benefit from the industrys rapid concentration. Building competitive advantage and creating superior value must be managements primary goals. Since its 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 studies that analyze the worlds top-performing companies in order to build an understanding of leading players. Winners in the Age of the Titans: Creating Value in Banking 2004, our second annual study of global banks, analyzes shareholder value creation in banking, including universal banks and specialist financial-services companies. For details of this reports approach, please see the Appendix, which examines our sample and methodology.

Walter Sinn

Ranu Dayal

David Pitman

Gerold Grasshoff

Thomas Herbeck

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NOTES TO THE READER

About the Authors Walter Sinn is a vice president and director in the Frankfurt office of The Boston Consulting Group. Ranu Dayal is a vice president and director in the firms New York office. David Pitman is a vice president and director in BCGs Sydney office. Gerold Grasshoff is a manager in the firms Berlin office. Thomas Herbeck is a manager in BCGs Frankfurt office. Acknowledgments Wed like to thank several peopleincluding many from the Financial Services and Corporate Finance and Strategy practice areaswho were involved in preparing this report. In particular, the authors would like to thank Robert Lauter. For Further Information For further information on the report and to learn more about BCGs value-management capabilities in financial services, please contact: Europe Walter Sinn Vice President and Director BCG Frankfurt +49 69 9150 2188 sinn.walter@bcg.com Related Studies Investment Banking and Capital Markets, Fourth Quarter 2003 Edition, BCG Report March 2004 The Path to Value Creation: Global Corporate Banking 2003, BCG Report November 2003 Back to Fundamentals, BCG Value Creators Report 2003 Succeed in Uncertain Times: A Global Study of How Todays Top Corporations Can Generate Value Tomorrow, BCG Value Creators Report 2002 Breakups Are Not the Only Solution, BCG Conglomerates Report 2002 Dealing with Investors Expectations: A Global Study of Company Valuations and Their Strategic Implications, BCG Value Creators Report 2001 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 Winners in the Age of the Titans: Creating Value in Banking 2004, please contact us at vcrfs2005@bcg.com. Americas Ranu Dayal Vice President and Director BCG New York +1 212 446 2986 dayal.ranu@bcg.com Asia-Pacific David Pitman Vice President and Director BCG Sydney +61 2 9323 5661 pitman.david@bcg.com

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EXECUTIVE SUMMARY
Market values for banks recently rose to high levels, exceeding the peaks of 2000 and 2001. To reach these unprecedented valuations, the banking industry clearly outperformed the overall market during the five year period between 1999 and 2003. Banks showed their strongest performance yet in 2003, when their total shareholder return (TSR) was 45 percentsubstantially above shareholder returns for the overall market. A stock market appreciation of more than $1.3 trillion in banks total market capitalization was backed by improved fundamental performance. But market expectations for banks future performance increased even faster. In fact, changing market expectations drove volatility in bank valuations. Higher profitability and growth improved fundamental values. An increase in average return on equity after tax (ROE) from 13 percent to 14.4 percent from 2002 to 2003, together with a doubling of the organic growth rate to almost 7 percent, drove fundamental values in banking in absolute terms to unprecedented levels. Companies with extraordinary profitability can be found in nearly every country; only two countries, Germany and Japan, experienced a significant profitability squeeze, with banks there operating on average with negative ROE in 2003. Growth and consolidation were high on the agenda as more competitors used the growth lever and as a few U.S.-dominated global banking titans emerged. The five largest banks raised their market cap by 18 percent per year between 1999 and 2003, increasing their share in worldwide banking from 13 percent to more than 16 percent by the end of 2003. With the megamergers of Bank of America/FleetBoston and JP Morgan Chase/Bank One, two new banking titans are joining the still-exclusive company of Citigroup and HSBC, with market caps of more than $120 billion and an average size of more than $180 billion. By their presence alone, these giants will have significant impact on future consolidation worldwide. Investment banking outperformed other segments. With an average annual shareholder return of 13 percent between 1999 and 2003and one of 53 percent in 2003investment banking was the best-performing banking business. Three main drivers underpinned this excellent performance: successful cost-cutting programs, strong fixed-income activity, and expectations for the recovery of equity and advisory businesses. U.S. and U.K. banks dominate the performance rankings. True company performance is measured by risk-adjusted relative total shareholder return (RRTSR), i.e. by adjusting TSR for risk and for the varying impact of domestic markets. Lehman Brothers, HSBC, and Citigroup led the rankings during the five year period. Fundamentals drove stock market performance. Top performers combined above-average profitability of 18 percent with strong annual organic growth rates of 14 percent.
Banks Performed Strongly in 2003
TSR 19992003 2003 44.8% 37.8%

6.4%

1.5% All industries

Banking

Banks Profitability Increased in 2003

Average after-tax ROE

15.1%

13.0%

14.4%

2003 1999-2003

2002 2002

2003 2003

The Concentration of Market Capitalization Increased

Five largest companies share of total banking market capitalization

17% 13%

16%

1998 Dec. 31, 1998

2002

2003

Investment Banking Was the TopPerforming Business

Total shareholder return Expectation premium

53.4% 43% 35% 13.0% 1999-2003 2003

Banking

51% 40%

2002

2003

Investment banking

The Top Five Companies (1999 2003)

Ranking by RRTSR

Lehman Brothers HSBC Holding Citigroup Bank of Nova Scotia Barclays

11.7% 10.1% 10.1% 8.6% 8.5%

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I. THE STATE OF THE BANKING INDUSTRY Business Confidence Improved Substantially

At the beginning of 2003, there was considerable caution about the state of the world economy and even fear of deflation. In the second half of 2003, fiscal and monetary stimuli in many parts of the world contributed to a clear pickup in economic activity and a marked improvement in business confidence. Banks performed exceptionally well in 2003. The banking sector greatly benefited from the recovering economy. In fact, the total Exhibit 1. Banks Performed Exceptionally Well in 2003 market capitalization of the global banking industry during 2003 increased by 42 percent to $4.5 trilTotal market capitalization Total shareholder return (%) ($trillions) lion, exceeding the previous all+6.4% +1.5% +6.0% 44.8 time high of $4.2 trillion in January +16.5% +0.3% -9.1% -11.3% +42.2% 37.8 2001. In terms of returns to share32.5 4.53 holders (taking capital gains and 3.95 3.94 3.59 15.4 3.18 3.38 dividends into account), banking stocks significantly outperformed 5.1 the markets: they appreciated by 44.8 percent compared with the av-10.9 -12.9 -15.3 -16.2 -16.8 erage industry return of 37.8 per1999 2000 2001 2002 2003 EOY 1998 1999 2000 2001 2002 2003 cent. (See Exhibit 1.) Banks
(1)

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

All industries

Over the past five years, banking outperformed the overall market. Like many industries, bankings impressive one-year perform- Exhibit 2. Banking Stocks Outperformed the Average of All Industries Over Five Years ance in 2003 is partly explained by Total shareholder return, Total shareholder return, 2003 19992003 a lackluster 2002. Nevertheless, the Information technology 66.2% -4.4% underlying strength of banking is Engineering and machinery 56.3% 6.9% demonstrated by the fact that beBanking 44.8% 6.4% 42.6% 2.0% Automotive tween 1999 and 2003, the industry Chemicals 40.5% 6.8% Transportation generated a total shareholder return 39.5% 3.4% 36.0% 1.8% Utilities (TSR) of approximately 6.4 per35.4% -5.6% Telecommunications Oil and gas centfour times better than the 35.4% 11.4% Electricity 33.7% 1.5% global average and exceeded only Media and entertainment 32.6% 0.8% Retail 31.9% 2.3% by oil and gas, engineering and maInsurance 29.8% -0.2% chinery, and chemicals, which are Pharmaceuticals 20.7% 0.6% less vulnerable to short-term 37.8% 1.5% World movements in the economy. (See Exhibit 2.)
(1) (1)

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

Stock market appreciation in 2003 was backed by improved fundamentalsbut market expectations rose even faster. Market capitalization is composed of a fundamental value and an expectation premium. In fact, the $1.3 trillion increase in banking market cap in 2003 was driven equally by

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improving fundamentals and rising expectation premiums. However, growth in expectations was more significant: while funda- Exhibit 3. The Increase of Market Capitalization in Banking in 2003 Was Backed Up by Improved mental values grew 30 percent Fundamental Performance compared with 2002, the expectation premium grew by 60 percent, Expectation premium (banking worldwide) Legend from $1.1 trillion to $1.8 trillion. 49.4% 39.9% 41.6% 34.9% 40.2% Expectation premium in x% As a result, at the end of 2003, % of market cap 4.5 expectation premiums slightly Market capitalization 4.0 3.9 3.6 exceeded 2000 levels. (See Ex1.8 3.2 Absolute expectation 1.6 1.9 hibit 3.) premium 1.5 1.1
=

This analysis offers powerful 2.4 2.7 2.0 2.1 Fundamental value 2.1 messages about bank valuations based on analysis of company fundamentals over the past five years. It shows 1999 2000 2001 2002 2003 that changing expectations about the future performance of the sector had a substantial impact on the change in market capitalization during the 2001/2002 downturn and the recent upswing in 2003. It also corrects the perception that there was a fundamental crisis in the banking sector that drove the approximately $800 billion loss of market capitalization between 2000 and 2002. With fundamental values at record levels, confidence in banking is definitely back.
(1)

$trillions

market cap minus fundamental value

(1) If historic data for 2003 were not available, calculation was based on IBES consensus forecasts. Sources: T.F. Datastream; BCG analysis.

Higher profitability and recovering growth improved fundamental performance in 2003. Increasing profitability and growing while profitability is above the cost of equity are the primary ways to increase TSR. Both value levers are captured by the performance metrics added value on equity (AVE) and the change (delta) in added value on equity (DAVE). AVE is the difference between after-tax profits and the opportunity costs of alternative investments of equity capital. Dividing both quantities by equity yields the economic spreadin other words, the difference between return on equity (ROE) and the cost of equity (COE). In 2003, value creation in world bankingmeasured by AVE was driven mostly by profitable growth rather than increasing profitability. Although ROE rose from 13.0 percent to 14.4 percent, most of this increase was offset by the rising cost of equity, with the result that the economic spread increased by only 0.3 percent. Banks therefore maintained their spread while growing their invested equity base by 17.4 percent, almost double that of the previous year, resulting in a 16.3 percent increase in AVE. (See Exhibit 4.)
Exhibit 4. Fundamental Value Creation in 2003 Was Based on Increased Profitability and Growth
Profitability and cost of equity
17.5% 14.0% 13.0% 14.4%ROE(1)

Growth (3) of equity in banking ($ trillions)

18.0%
7.3%
9.6%
17.4%

16.7%

11.3%

COE
9.3% 9.5% 9.8% 10.9%

1.28

1.51

1.62

1.78

2.09

1999

2000

2001

2002

2003 (2)

1999

2000

2001

2002

2003 (2)

Added value on equity ($ billions)

78.4%

123

-40.9%

-22.3%

27.6%

69

73

57

72

1999

2000

2001

2002

2003

(1) After tax. (2) If historic data for 2003 were not available, calculation was based on IBES consensus forecasts. (3) Organic and external growth. Sources: T.F. Datastream; BCG analysis.

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Solid underlying growth in profitably invested equity drove the rebound in market capitalization. This growth has led to renewed confidence in the sector reflected in a large increase in the expectation premium. The challenge in the future will be to justify growing expectations with strong fundamental performance. Increasing confidence in banking reinforced improved fundamentals. Continued strong performance is necessary to justify growing expectations.

Growth and Consolidation Reappeared on the Agenda

Accelerating growth is at the top of the CEO agenda. Stock markets reward change, which is generated either by an increase in ROE or by profitable growth. The lever with the greatest impact on value creation is organic growth. Adjusting overall equity growth rates for mergers and acquisitions and the impact of currency fluctuation shows organic growth rates of 6.7 percent in 2003, almost double the 3.5 percent organic growth rate in 2002. (See Exhibit 4.) However, these figures are still far below the 2000 organic growth rate of 18 percent and do not match the average annual organic growth rate of 9 percent between 1999 and 2003. Developing new products and services only after developing a deep understanding of customers and clients is vital to improving growth as the industry consolidates rapidly. Market capitalization is increasingly concentrated. The share of global bankings market value, represented by the five biggest Exhibit 5. The Concentration of Market Capitalization in the Banking Industry Is Increasing banks, has increased from 12.9 percent to 16.1 percent in the past Concentration of market Share of five Growth of average market cap, capitalization biggest companies 19992003 five years. The top five banks by market value in 2003 have ex% of total market capitalization panded their market cap, on averDec. 2003 100% 100% age, by 17.9 percent per year over Dec. 1998 the past five yearsmore than 17.9% twice as fast as their mid-cap 8.5% 7.4% competitors. (See Exhibit 5.) In 6.2% 5.2% 16.1% 12.9% the small-cap segment, apprecia 1-5 6-20 2150 51-100 >100 tion was still better. This increase Dec. 31 Dec. 31 2003 1998 % of total listed companies Biggest at Dec. 31, 2003 can be attributed partly to small banks being perceived as takeover Mergers and acquisitions drive the market capitalization increase of five biggest companies targets, which adds a premium to their value.
100% 80% 60% 40% 20% 0%

0%

20%

40%

60%

80%

100%

Sources: T.F. Datastream; BCG analysis.

New banking titans are changing the consolidation game. The continued consolidation of the largest banks is creating a new era: the age of the banking titans. With the megamergers of Bank of America/FleetBoston and JP Morgan Chase/Bank One added to established giants Citigroup and HSBC, there are now four banking titans, each with market caps of more than $120 billion and an average size of $180 billion. (See Exhibit 6.) To create value from mergers and acquisitions, it is imperative to realize the necessary cost and revenue synergies. The primary sources for value creation have traditionally been cost synergies from re-

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ducing the geographic overlap of retail branches. This has been the driving force for the large deals among regional players in the late 1990s and for most of the continuing domestic mergers and acquisitions.

Exhibit 6. The Biggest Banks Are Becoming Even Bigger

Market capitalization ($billions)

280 240 200 160 Citigroup The Royal Bank of Scotland

Santander Central Hispano

The megamergers that created the 120 two latest banking titans lack 80 geographic overlap in their retail 40 branch systems and, thus, the corresponding cost reduction poten0 0 10 20 30 40 50 60 70 80 90 100 tial. They therefore have to realRanking by market capitalization ize cost synergy savings in other areas, such as corporate center functions and IT. Such synergies, however, tend to be smaller and harder to realize. The standardization and harmonization of productsand the resulting processing, operations, and product management synergiesoffer more cost-saving potential. Revenue synergies from increasing sales of existing products to an expanded customer base or improved pricing strategies tend to be even harder to realize and are usually smaller in scale. Nevertheless, it is possible to create shareholder value from M&A without branch overlaps. For example, top-performing banking titan HSBC has successfully raised profitability while following a cross-border expansion strategy, without the benefit of geographic overlaps.
Sources: T.F. Datastream; BCG analysis.

Mitsub. Tok. Finl. Gp. Mitsuho Financial Group HSBC Holdings Crdit Agricole Bank of America/ UniCredito Italiano Fleet Boston National Australia Bank Nomura Holdings JP Morgan Chase/ Royal Bank of Canada Bank One Commonwealth Bank of Australia Banca Intesa Wells Fargo Bank of Nova Scotia UBS ANZ Banking Group Barclays Toronto-Dominion Bank Sanpaolo IMI Commerzbank BNP Paribas HBOS Banco Popular Espaol Deutsche Bank HVB Group Socit Gnrale Lloyds TSB BBVA Credit Suisse

We expect the banking titans, by their presence alone, to exert influence on the strategy of other global players. Focusing on operations that are subscale compared with the titans and following slow organic growth strategies are unlikely to guarantee independence anymore. The tremendous acquisition power of the banking titanswith the smallest of the four almost double the size of the largest specialistscreates tremendous imbalances. A new challenge for top management is to successfully survive in the age of banking titans. We foresee three main potential consolidation scenarios. In the first scenario, the titans would take an active part in European and Asian consolidation and primarily target leading national champions in major banking markets in those regions. In the second scenario, the titans would focus more on consolidation in the U.S. market, where there is less risk and where synergies are easier to realize. In the third scenario, domestic and regional players would take the lead in driving European and Asian consolidation. For Europe, this would certainly produce further consolidation in national markets (especially in Germany and Italy), but it would also increase the probability of large cross-border deals within the region. There are, moreover, significant barriers to entry in many major banking markets. These may make it hard for the titans to flex their muscles in certain national markets. M&A transactions picked up in Asia-Pacific and Europe. U.S. companies led the merger boom of the late 1990s. That boom suffered a considerable slowdown in the United States when the countrys economy faltered. Global M&A activities outside the United States, however, continued to grow, albeit more slowly than in the United States.

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Consolidation among banks in Exhibit 7. The Number of M&A Transactions in Banking Is Increasing Europe and Asia-Pacific is now Volume 1600 Number 400 Within increasing. Smaller banks without of deals of deals North America ($billions) 300 1200 defensible niches and business Trans200 800 Within Europe actions models are likely to become ripe within 100 Within 400 respective Asia-Pacific candidates for mergers and acquiregion 0 0 sitions. Overall, the number of 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 North America Europe Asia Pacific transactions across regions is picking up rapidly. North American Number 12% North American banks Asian-Pacific banks of crossbanks in particular have acquired European banks 10% regional 8% deals other players outside the United Trans6% actions across States and Canada, making their 4% regions 2% share of inter-regional deals jump 0% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 from 6 percent in 2002 to 12 percent in 2003. (See Exhibit 7.) Citigroups purchase of Korean KorAm bank for about $2.7 billion is just one recent example.
Sources: T.F. SDC; BCG analysis.

In the dawning age of the titans the following questions are gaining more and more importance. How should you sustain competitive advantage in the age of the banking titans? At what level of market capitalization does the number of predators threatening you decrease significantly? And, conversely, at what level do you become a predator yourself? What sort of deal, either as an acquirer or as target, would provide a measurable bottom-line impact on your company and thus create additional value for shareholders? How can you best prepare for playing an active role in banking consolidation?

Investment Banking Outperformed Other Segments

Sensitivity to market movements depends considerably on business focus. We classify banks either as universal banks offering a broad range of products in retail and corporate banking, or as members of five specialized banking segments. These segments are asset managers, consumer finance companies, investment banks, mortgage finance companies, and transaction banks. (For definitions of these segments, please see the Appendix.) These groups have distinct differences in their business models, which means they operate with different risk-return dynamics and tradeoffs. TSR should not be compared without taking this fact into account. Two extremes illustrate the point. On the one hand, investment banks and asset managers, whose revenues depend on prospering capital markets, show a high degree of sensitivity to market movements. On the other hand, companies in mortgage financing are much more stable with respect to market movements: they tend to underperform in upswings and outperform in downturns. (See Exhibit 8.)

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Investment banks outperformed all other segments, with a 13 percent TSR between 1999 and 2003. Equity markets staged a Exhibit 8. Investment Banking Showed the Best Shareholder Performance Between 1999 and 2003 gradual recovery in 2003, with a pronounced upturn in the last 53.4 46.3 44.8 35.5 35.3 Total shareholder quarter. Investment banks were 35.7 return, 19.6 2003 (% ) the best-performing segment and generated a TSR of 53.4 13.0 percent in 2003 and 13 percent Total shareholder 6.5 between 1999 and 2003. Even 6.4 5.4 return, 4.6 19992003 (% ) 2.7 2.1 after allowing for the volatility of investment banking, this is still a remarkable return. Uni1.6 1.6 1.1 1.2 1.2 Average market 1.1 versal banks followed, generat0.8 sensitivity, 1999-2003 ing a 46.3 percent TSR. Mortgage finance companies trailed, Universal Investment Consumer Transaction Asset Mortgage Average banks banks finance banks managers finance Banks with a TSR of 19.6 percent in companies companies 2003 and 4.6 percent over the five year period. Such companies benefited least from the market surge.
Sources: T.F. Datastream; BCG analysis.

As highlighted earlier, the increase in market capitalization in 2003 is backed by fundamentals, but expectations for future performance have risen even faster. Individual segments reveal a more differentiated picture: while the in- Exhibit 9. Investment Banks Gained the Most Benefit from Increasing Market Expectations crease in market cap for inMarket expectation versus Change of market expectation, vestment banking owes mainly shareholder performance, 2003 2002 versus 2003 Valuation 70 Valuation 70 to rising expectations, market Transaction Increasing level level Asset managers 60 60 banks Transaction expectations Asset (expec(expecexpectations for mortgage fibanks tation tation Investment managers 50 50 Investment premium Consumer premium banks nance companies decreased banks Consumer 2003 , finance 2003 , 40 40 Universal finance companies in % ) in % ) banks Universal considerably. In other words, 30 30 companies banks 20 year 20 20 given the challenges that segbanking average 10 10 ment currently facesmargin Mortgage 0 0 finance pressures and rising interest -10 -10 companies Mortgage finance Decreasing ratescapital markets do not -20 -20 companies expectations -30 -30 consider the current profitability -30 -20 -10 0 10 20 30 40 50 60 70 0 10 20 30 40 50 60 70 and growth figures for mortgage Total shareholder return, 2003 (% ) Valuation level (expectation premium 2002, in % ) finance sustainable over a long period. (See Exhibit 9.)
(1)

(1)

(1) If historic data for 2003 were not available, calculation was based on IBES consensus forecasts. Note: All data were calculated after conversion to U.S.$. Sources: T.F. Datastream; BCG analysis.

Investment banks excellent performance was driven mainly by exceptional fixed-income activity. The 53 percent total return to shareholders for investment banks in 2003 was driven by healthy fixed-income business and a pickup in general capital-markets activity. The leaders of the investment banking industry, which are covered in BCGs quarterly Investment Banking Report, reported 2003 revenues that amounted to their second-best year ever. Gross margins improved from 25.5 percent in 2002 to 32.3 percent in 2003, slowly returning to levels considered normal before the market decline of 2001.

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A closer look reveals that there are three drivers of investment bankings improved performance: 1. Successful Cost-Cutting Programs. Widespread cost cutting in the past three years contributed to the bottom line. From April 2001 to February 2003, about 80,400 securities employees (nearly 10 percent of the industry) lost their jobs. For instance, Merrill Lynch, which at the end of 2000 employed 72,000 people, cut its staff to 48,100 and reduced bonuses. Furthermore, investment banks reduced communications and technology costs, as well as advertising, travel, and office expenses. 2. Strong Fixed-Income Activity. Falling interest rates, widening credit spreads, and the prospect of an economic recovery boosted fixed-income revenues and profits. Out of the total $49 billion of profits earned in 2003, trading in debt-related products accounted for $31 billion. 3. Expectations on Equity and Advisory. Equity trading and M&A advisory remained stable during the first three quarters of 2003 but surged in the fourth quarter, with a positive outlook for 2004 driving up expectations of future performance of investment banks. While the return of confidence in the stock market may herald a further upswing in the equities and advisory businesses, significant improvements are needed to compensate for a potential decline in fixed-income activity. Note that corporate finance revenues have to increase by more than 50 percent in order to make up for a 20 percent decline in fixed-income trading revenues. Lehman Brothers stands out among the investment banks that performed exceedingly well. Its recent success is based on forward-looking management, a winning mix of businesses, and tight control of costs. The firms strong fixed-income franchise, in particular, has helped it prosper over the past 12 to 18 months, as debt markets have thrived in the continued low interest-rate environment. Lehmans seasoned management also used the firms strong currencyits stock market valueto buy Neuberger Berman, an established asset manager, thereby broadening its mix of businesses. Lehmans strategy allowed it to increase after-tax profit by 45 percent, to almost $1.7 billion. It has outperformed the national stock market for five years in a row, putting an average 29 percent in annual returns into the pockets of shareholders and making Lehman the top-performing company among the 100 largest banks worldwide. Remember that the higher returns of most specialists are usually paid by higher risk. Be aware of the very different segment-specific market expectations. Learn from investment banks: their highly responsive senior managers show that quick and radical cost alignment in a market downturn pays off.

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Strong Performance Existed Across Countries

Half of big banks $4.5 trillion market cap is concentrated in the United States and the United Kingdom. More than 80 percent of all market capitalization in banking worldwide is concentrated in just ten countries. Even among those countries the distribution is quite skewed. Out of the top 15 largest banks 12 are from the United States and the United Kingdom. (See Exhibit 10.) Major markets in banking showed large differences from the shareholder point of view. France, Canada, and Australia are home to the top-performing banks over the five year period, with impressive average annual TSR above 16 percent. Germany, the top-performing nation with a shareholder return above 80 percent in 2003, shows a slightly negative TSR on a five year basis. (See Exhibit 11.)
Improving expectations drove the exceptional increase in Germany and Japans market cap in 2003. Meanwhile, the improved performance of Australia, Switzerland, and the United Kingdom was driven largely by improved fundamentals. In Germany, increasing market capitalization and decreasing fundamental value might seem paradoxical. In fact, German banks cleaned up their balance sheets in 2003, reducing average profitability but resulting in decreasing fundamental value. Meanwhile, expectations of a consolidation in German banking substantially increased market capitalization. (See Exhibit 12.)
Exhibit 10. Geographic Distribution of Market Capitalization in Banking Was Quite Skewed

Share of market in worldwide banking, 2003

United States

United Kingdom
41% 11.1%

Italy France Switzerland

3.6

3.3 3.2

23.7%

Canada

Rest of world Rest of Asia-Pacific Australia

3.2% 6.6% 2.5% 9.0% 2.9%

Continental Europe

Spain Germany Rest of Europe

3.1

Japan

2.6

7.9

Sources: T.F. Datastream; BCG analysis.

Exhibit 11. Main Countries in Banking Showed Large Differences from Shareholder Point of View
Total shareholder return, 2003(1)
Total shareholder return, 19992003(1)

Germany Spain Japan Italy Canada France Australia Switzerland United Kingdom United States World
(1) Includes capital gains and dividends. Note: All data were calculated after conversion to U.S.$. Sources: T.F. Datastream; BCG analysis.

80.2% 64.3% 62.8% 60.8% 56.8% 56.8% 51.0% 49.6% 38.5% 35.1% 44.8% -1.7% -0.6%

-0.1% 4.5%

18.0% 18.5% 16.5% 5.6% 8.5% 7.1% 6.4%

Exhibit 12. The Increase in Market Capitalization in Banking Was Driven Mainly by Rising Market Expectations
Market expectations versus shareholder performance(1) 70% 60% Japan
Germany - 7.7 80.2 62.5 18.9 30.7 20.4 35.4 -2.3 42.7 38.1 16.9 11.3 21.5 19.3 1.2 36.4 24.3 32.8 11.7

Share of rising expectations in increase of market cap 2003(2)

72.5% 70.6% 55.3% 55.0% 53.2% 47.1% 40.4% 39.3% 38.4% 30.6%

Germany

Japan Italy

8.1

Current 50% valuation level 40% (expectation premium, 2003(2)) 30%

20% 10%

United States Switzerland

Canada

Spain Italy

Spain Canada Australia Switzerland United Kingdom France United States

France Australia United Kingdom

20 year banking average

30%

40%

50%

60%

70%

80%

90%
Country
Fundamental value [%]
Expectation premium [%]

Recent upswing (TSR 2003)

Increase in market cap

(1) Including capital gains and dividends. (2) If historic data for 2003 were not available, calculation was based in IBES consensus forecasts. Sources: T.F. Datastream; BCG analysis.

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We distinguish three broad groups of countries when it comes to banking fundamentals. When comparing performance and growth, the ten countries can be divided into three major groups with similar characteristics. The large group, depicted in Exhibit 13 in the bubble toward the upper right corner, has delivered equity growth rates and economic spreads that are generally above the global average. Canada and Switzer- Exhibit 13. Different Country Groups Have to Focus on Different Value Levers land, however, pushed average profitability well above the cost of equity and had less sucCountry groups and value levers, 2003 Profitability Stars by Country, ROE 2003 cess in creating value through Profitability star Country average Econo- 20% growth. In the second group, Focus: mic growth 18.0 53.4 Sallie Mae spread 15% United United France and Italy delivered re2003 Kingdom States 16.2 34.5 Lloyds TSB 10% Australia Switzerland Spain turns below or only just above 17.3 22.7 BBVA 5% World Canada Focus: Bank of Nova Scotia 15.4 18.9 0% the cost of equity. For them, France profitability 17.8 Italy 18.8 UBS -5% the basic focus should be to 14.8 ANZ Banking Group 17.1 -10% increase profitability above 8.7 16.1 Unicredito Italiano Germany -15% Japan 11.4 14.5 BNP Paribas cost of equity before growing -20% World -1.2 4.3 Deutsche Bank -20% -10% 0% 10% 20% any further. The third group, Organic growth 2003 -5.7 0.6 Nomura Holdings Germany and Japan, still has a long way to go and needs to focus on restructuring.
(1) (1)
(2)

United States

United Kingdom Spain

Canada

Switzerland

Australia

Italy

France

Germany Japan

(1) If historic data for 2003 were not available, calculation was based on IBES consensus forecasts. (2) Difference between return on equity and cost of equity. Sources: T.F. Datastream; BCG analysis.

Of course, averages do not tell us everything: in almost every country, there are large banks that comfortably exceed average profitability. (See Exhibit 13.) Sallie Mae led our profitability ranking with an impressive after-tax ROE of 53 percent. For a closer look at country markets, we haven chosen to spotlight Australia because it is the most successful country by TSR in 2003 in the dynamic AsiaPacific region. Australia is growing through prosperous consumer and mortgage businesses. At the country level, Australia has turned in the most impressive TSR results. Between 1999 and 2003, the four major Australian banks (ANZ Banking Group, Commonwealth Bank of Australia, National Australia Bank, and Westpac) achieved a combined TSR of 11.3 percent per year and increased their collective AVE by 17.5 percent. Four factors have underpinned their success. First, the banks made remarkable progress in terms of efficiency. Cost-to-income ratios have fallen by 4.4 percent per year for ten years. Relentless efficiency improvement programs have focused on automation, process reengineering, overhead productivity, and outsourcing, as well as a sizeable migration from physical to electronic transactions. (Less than 10 percent of transactions are carried out in branches today.) In addition, the fee-interest mix has shifted dramatically as banks have repriced products and services to remove cross-subsidies. Second, strong growth in consumer credit has been fueled by low interest rates and a buoyant local economy. These factors produced a 22 percent annual growth in household debt and a six year boom in the property market, but they have also given rise to third-party mortgage brokers and originators, whose competitiveness has almost halved the industrys mortgage profitability since the late 1990s. Despite this, and signs that the property market has now stalled, we estimate that home lending still represents around 20 percent of the big banks domestic profits.

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Third, banks have acquired new income streams, such as wealth management; in so doing, they have broadened the definition of the market from banking to financial services. This growth was in part the result of federal government regulations that specify minimum contributions to private-pension funds. Fourth, performance management practices have been modernizedimproving the internal transparency of where and how value is being created; enhancing the focus on accountabilities, rewards, and recognition; and developing a performance culture. In the short term, the Australian banks have room to make further progress on costs and performance management practices. In the longer term, growth will inevitably become even more central to their value-creation aspirations, bringing special challenges that stem from unique structural factors. Such factors include the industrys relatively high concentration; the governments four pillars policy, which constrains local big-bank mergers; and Australias small-economy status, which has traditionally made cross-border transactions and growth difficult. In the future, these factors are likely to lead the major Australian banks to review their portfolios of businesses across segments, products, and geographies. It will be difficult, if not impossible, for most countries to repeat 2003s high double-digit TSR. Superior profitability is possible in almost every country. In country groups with low profitability, such as Germany and Japan, banks should exclusively focus on improving ROE. Growth will be the key value lever in the years to come.

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II. THE PATH TO VALUE CREATION

It is important to understand the real drivers of value creation at top-performing banks. First, we consider external (stock market) performance; then we examine internal (fundamental) performance.

Stock Market Stars

Lehman Brothers, with a 29 percent annual return, put the most money into the pockets of shareholders, including capital gains and dividends. Among large-cap banks, the 50 largest banks worldwide, Lehman Brothers was the company that delivered the highest TSR between 1999 and 2003, whereas FleetBoston ranked number one for 2003mainly because of the announcement of its forthcoming merger with Bank of America. (See Exhibit 14.)
Exhibit 14. Top Ten Performers by Total Shareholder Return
TSR measures capital gains and dividends
19992003
Lehman Brothers
29.3% 20.3% 17.8% 17.5% 16.7% 15.9% 15.3% 15.0% 14.7% 14.1%

Top performers by TSR

2003
FleetBoston
JP Morgan Chase Merrill Lynch

88.1% 60.3% 56.8%

TSR

Socit Gnrale

Citigroup
Bank of Nova Scotia

Sumitomo Mits. Fin. Grp. 56.0% Banca Intesa Deutsche Bank Credit Suisse Santander Centr. Hisp. Morgan Stanley

Capital gain

ANZ Banking Group Royal Bank of Scotl. Bank of Montreal

55.3% 53.5% 51.3% 48.6% 47.9% 47.9%

Dividends

Value at start of period

Dividends

Value at end of period

HSBC Holdings Hang Seng

Nomura Holdings
Note: The sample consists of the 50 largest banking companies by market cap in 2003. Sources: T.F. Datastream; BCG analysis.

Nordea

We measure company performance by risk-adjusted relative total shareholder return (RRTSR). TSR measures how successful an investment strategy has been in terms of money earned for the shareholder. But TSR does not tell the whole story when the question is, how well did a company perform? For that purpose, it is important to adjust for two effects: the influence of national stock markets and the risk to which the shareholders have been exposed. To that end, BCG has developed RRTSR, a performance measure that captures shareholder returns, just as TSR does, and at the same time normalizes for these two effects. The first adjustment acknowledges that stock prices are related to the overall development of ambient national marketsan effect that management has little influence on. What counts is a companys stock price performance relative to the overall market. RRTSR filters out the impact of the overall stock market on the specific stock, thus enabling comparisons among companies in both bull and bear markets over the same period.
Exhibit 15. Outperforming the Market Is a Difficult Task

Outperforming the national stock market 19992003: the biggest 100 companies in banking

23
Large-cap (150)
Mid-cap (51100)

22 17

Socit Gnrale Lehman Brothers Standard Chartered Bear Stearns

13 8

7 5 0
0x

0
0x

1
1x
1x

2
2x 3x 4x 5x

2x

3x

4x

5x

Number of years the market outperformed

The second adjustment relates to company-specific risk. Companies follow different business strategies in different banking segments,
Sources: T.F. Datastream; BCG analysis.

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which in turn translate into various levels of volatility for these companies stocks. Investors generally believe a simple rule: the riskier an investment is, the more return is expected. In other words, company stock performance should be compared on a risk-adjusted basis. RRTSR does just that, allowing performance comparisons among companies in high and low volatility segments over time. Beating the national market over five years is difficult. In fact, out of the largest 100 companies in banking, only investment banks Lehman Brothers and Bear Stearns, and universal banks Socit Gnrale and Standard Chartered1 beat their national markets five times in five years. (See Exhibit 15.) Lehman produced an exceptional TSR in a relatively weak national stock market. And despite the high volatility of the stock, the company ranked first in RRTSR Exhibit 16. The Top Ten Performers by RRTSR from 1999 through 2003.
RRTSR adjusts for risk and the

impact of the national market

Top performers by RRTSR 19992003 2003

HSBC Holding Fleet Boston Hang Seng Bank of Montreal Westpac Wells Fargo U.S. Bancorp Bank One Banca Intesa Sun Trust 21.1% 13.4% 9.2% 9.1% 6.9% 6.7% 5.3% 4.1% 3.9% 3.4%

The low volatility of HSBC stock triggers a jump in the companys performance ranking. HSBC ranked a close second to Lehman, propelled by an impressive TSR in a weak U.K. stock market with relatively low company-specific volatility. (See Exhibit 16.) This combination of factors meant that ranking eighth in terms of TSR translated into a second place in terms of RRTSR.

TSR

Lehman Brothers HSBC Holding

11.7% 10.1% 10.1% 8.6% 8.5% 8.5% 8.3% 7.8% 7.4% 7.3%

Filtering out the impact of national stock market

Citigroup Bank of Nova Scotia Barclays

Risk adjustment

Bank of Montreal Royal Bank of Scotl. Socit Gnrale

RRTSR

ANZ Banking Group Merrill Lynch

Note: The sample consists of the 50 largest banking companies by market cap in 2003. Sources: T.F. Datastream; BCG analysis.

The creation of shareholder value is the ultimate goal for each company. Adjusting TSR for the impact of national stock markets and for company-specific risk results in a more accurate measure of company performance: RRTSR. Consider longer periods (say, five years) to set yourself external targets. Translate external targets into internal business return targets.

Profitability and Growth Stars

The analysis of external company performance begs the question, how much did fundamental performance drive external value creation? To answer that question, we took a closer look at the 100 largest banks worldwide to understand what made the top ten performing banks stand out. In addition to the top five from the large-cap segment (Lehman Brothers, HSBC, Citigroup, Bank of Nova Scotia, and Barclays), we analyzed the fundamentals of the top five of the mid-cap segment (Golden West Financials, Bear Stearns, M&T Bank, Sallie Mae, and South Trust.) Fundamentals drove average shareholder performance of 20 percent at the top ten. Fundamental value can be calculated in several ways. The most common method is to discount the future cash flows the business is expected to generate. For our purposes, we valued businesses somewhat differ1

HSBC and Standard Chartered, although based in London, are large banks with global operations.

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ently leading to the same results: we took the book value of equity invested in the business and added the present value of the sum of future AVE. The internal measure corresponding to TSR is total business return (TBR). It is calculated in roughly the same way as TSRexcept that instead of using market capi- Exhibit 17. Top Ten Banks Show Strong Shareholder Performance Driven Fundamentals talization, TBR uses fundamental value based on AVE. TBR enables companies to assess the Fundamental performance 19992003 Average total shareholder return, 19992003 value creation of individual business units in a manner consistent with the shareholder per25.2% spective and therefore enables 19,9% 16.0% value-based portfolio manage9.1% ment. Transparency over where -6.7% -7,6% and how value is created interBottom ten Average Top ten Bottom ten Average Top ten nally is critical as management companies companies seeks to allocate scarce resourcesfor example, people and equityto their best available use, continually balancing between profitability and growth.
(1) , (2)

(1) Percentage change in fundamental value, including free cash flows to shareholders (TBR). (2) If historic data for 2003 were not available, calculation is based on IBES consensus forecasts. Note: The sample consists of the 100 largest banks; top ten and bottom ten RRTSR performers from large- and mid-cap size groups. Sources: T.F. Datastream; BCG analysis.

The research shows that the top ten performing banks achieved a TBR of 25.5 percent per year from 1999 to 2003 and drove their stock appreciation by an average of 19.9 percent per year. (See Exhibit 17.) The correlation between the two outcomes is not surprising and illustrates the equivalence of the TSR and TBR metrics: just as external value creation is broadly determined by the change in market capitalization, so internal value creation is determined by the change in fundamental value.

Exhibit 18. Top Performers Are Growing Profitably

After-tax ROE

Organic growth of equity

21%

Top ten
17%

18% 16% 16% 17% 16% 15% 14% Average 15%

19%

18%

23% 14% 12% 9% Top ten 15% 12% 8% 10% 11% 9% 4% -1% 14% 6%

14%
9% 3%

14% 12%

15%

Average

Bottom ten

3%

3%

10%

Bottom ten
1999 2000 2001 2002
(1) 2003

-15% 2002
(1) 2003

(1)

Average 19992003(1)

1999

2000

2001

Average 19992003 (1)

(1) If historic data for 2003 were not available, calculation was based on IBES consensus forecasts. Note: The sample consists of the 100 largest banks; the top ten and bottom ten RRTSR performers from large- and mid-cap size groups. Sources: T.F. Datastream; BCG analysis.

Top performers delivered almost 20 percent ROE and grew by 14 percent per year. The top performers appear to do a better job of managing performance and growth simultaneously. The top ten performers increased or sustained high profitability, with ROE in the high teens, even during the market downturn and at the same time averaged a 14 percent equity growth over the five year period. By contrast, the bottom ten performers experienced a substantial squeeze in profitability far below their cost of equity and managed to achieve growth of only 3 percent over the five years, including a contraction of 15 percent in 2002. (See Exhibit 18.)

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Poor performers must meet the challenge of creating value or face the possibility of a limited future as an independent entity. Those that step up to the challenge and manage their way to a more prosperous future typically do so by following the so-called Euro-curve path. (See Exhibit 19.) This path consists of a three-step process. The first step is to define the strategy and align the organization accordingly. Identify those businesses that are underperforming and do not fit with the strategic or value creation aspirations of the company. Unless there is a compelling strategic rationale for keeping these businesses, they must be seriously considered for divestment.
Exhibit 19. Grow -- But Only in Profitable Businesses

"Euro-curve principle

Three steps to value creation

ROE Grow by expanding profitable segments Cost of equity (range) Increase profitability (ROE) by downsizing 1

Position yourself

Do your homework: increase profitability (ROE)

3 Equity

Go forward: grow by expanding profitable segments

The second step consists of developing a plan for rejuvenating businesses that should be kept but are not earning their cost of equity. Unless they can be restored to a positive economic spread, growth will destroy value. Fixing such businesses usually entails some combination of redefined strategy, tough restructuring, cost cuts, and an increase in the price point of products. These are the challenges many German and Japanese banks currently face and that usually lead to a shrinking of the business portfolio.
Sources: BCG value management.

The third step is to expand profitable businesses without allowing profitability to fall below the cost of equity. The equity allocated to the expanded businesses determines the organic growth rate. U.S. and Australian banks managed this step very effectively over the last five years. Understand your position in the Euro-curve path. Grow, but only when and where the business is profitable. Increasing profitability is the only path for businesses with returns below the cost of equity.

Selected Success Stories

Four companies that lead our ranking enjoy exceptional business performance for very different reasons: ANZ Banking Group for increasing profitability, Barclays for sustained profitable growth, Sallie Mae for exceptional profitability and growth figures in a niche segment, and HSBC for successful external growth. ANZ Banking Group developed a distinct cost advantage. Between 1999 and 2003, ANZ Banking Group doubled its profits and became one of the worlds most efficient banks, with a cost-to-income ratio in the mid-40s. The banks performance-improvement program has relied on three elements:

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1. The bank introduced a simplified, disaggregated structure that provided strong, clear lines of accountability and autonomy for its 16 major businesses, each of which provided internal and external reports. 2. The CEO and centrally driven governance pushed this performance improvement by focusing on efficiency and accountability. This approach has involved strict, top-down target setting; allocation of all central costs to business units, with tight service-level agreements; a compensation system that motivates performance with a steep variable-reward curve; tough quarterly reviews of each business unit, led by the CEO and CFO; and individual performance contracts. 3. To direct efficiency programs, management has invested in developing a detailed understanding of the cost structure of the bank, based on very simple goals for both revenue growth and cost reduction. The outcome of this program has been that even though the bank is smaller than its national competitors, it now has a distinct cost advantage, which it has used to become more competitive on price and to return greater profits to shareholders. As a result, ANZ has achieved a 45 percent cost-to-income ratio and has delivered ROEs of more than 20 percent, making it the most profitable of Australias major banks. Develop a clear vision for improving your cost-to-income ratio. Require senior management to make uncompromising commitments to meeting targets. Adopt a never spend an additional dollar philosophy. Ensure clear accountability, substantial rewards for performance, and strong sanctions for missing targets. Maintain a strong belief that there is always more to do. Barclays delivered sustainable growth. Barclays highlights the opportunities for growth. It now ranks third among the dominant British banking institutions and twelfth internationally by market capitalization. Having a highly diversified business model (the group's main activities concentrate on personal financial services, credit cards, private clients, business banking, and investment banking), Barclays management understood how to generate double-digit growth in almost every field. A closer look at the credit card business helps explain Barclays success. In 2003, Barclays recruited a record 1.5 million new customers to reach 10.6 million Barclaycard holders in the United Kingdom. Aggressive marketing strategies such as matching rivals cheapest interest rates and cobranding contributed to this increase. Additionally, strong consumer spending, combined with risk-pricing expertise, led to annual profits of 68 per cardholder (versus 63 in 2002). Barclays is now trying to duplicate this achievement in its international credit-card franchise: Barclaycard International just turned profitable for the first time. Several factors have contributed to Barclays' success: its credit-card business, its business-banking franchise, and effective cost-reduction efforts. In addition, its investment-banking business, Barclays Capital, which specializes in fixed-income business, has done especially well during years of declining interest rates. On the retail side, Barclays is now working to integrate its retail product lines (current accounts, investments, loans, credit cards, mortgages, insurance, pensions, and student and travel

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services). The bank has also been successful at bundling products (particularly with its Openplan offering) in an effort to increase customer penetration. These accomplishments resulted in impressive financial figures. Within the last five years Barclays has grown more than 12 percent per year while operating at an average economic spread of about 7 percent. That makes it the second-best performing bank on the European stock markets. Establish a full product line to capture growth opportunities. Increase cross-selling rates by offering smart product bundles. Leverage existing business lines into new geographical markets. Follow an aggressive marketing strategy in core businesses. Develop a strong brand and team up with other renowned names.

Sallie Mae profited from consumer loans. SLM Corporation, better known as Sallie Mae, is a fastgrowing consumer loan provider that operates extremely profitably. The financial institution offers the student market educational credit products and related services. Such offerings include a strong student loan origination that increased its volume of loans by 13 percent in 2003 and had 7 million customers by the end of that year. Sallie Mae grew its core cash student loan spread from 1.91 percent in 2002 to 2.21 percent in 2003. Its after-tax profit increased by 77 percent and reached an all-time high of $1.4 billion. The company manages an impressive $87 billion portfolio of student loans. Over the last five years, SLM generated an average ROE of 42 percent. In 2003 its ROE increased an astonishing 53 percent, making the company the most profitable bank among the 100 largest financial institutions worldwide. Sallie Mae was valued at $17 billion at the end of 2003. It rewarded shareholders with annual average returns of about 20 percent for the last five years. With or without adjusting for risk, Sallie Mae ranks first among consumer-finance companies worldwide. It is important to note that in 2003 Sallie Mae benefited from a friendly market environment. Demand for student loans increased temporarily for three reasons: first, compared with previous years, the number of teenagers planning to attend college rose; second, because of state budget crises, the amount of money allotted to public schools decreased; and third, the weak economy cut privateschool endowments. The capital markets seemed to take into account these effects; otherwise we might have seen an even higher market appreciation. Niche markets can hold huge potential. Double-digit profitability and growth can be achieved simultaneously. Never stop pushing for higher margins. Efficiently allocate scarce capital resources. Take favorable macroeconomic conditions into account.

HSBC adopted a successful string of pearls acquisition strategy. The banking titan HSBC Holdings has grown its worldwide presence with the successive acquisitions of the Republic National Bank of New York, Crdit Commercial de France, and more recently Household International. It operates almost 10,000 branches in 79 countries in Europe, the Middle East, Asia, and the Americas.

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By expanding its business into new regions, HSBC follows a pattern of organic growth along with growth through acquisitions. It follows three consecutive steps. First, it identifies potential new markets and then establishes a foothold through a local subsidiary. This approach allows HSBC to learn about the market without too much capital expense; simultaneously, HSBC looks for potential partners with strong operations in the new market. Second, by taking a minority stake in a local partner, HSBC enhances its presence with the reputation, knowledge, and customers of the affiliate. Third, after a period of organic growth, HSBC usually acquires a controlling majority of the partner and integrates the operations into its global network. Remarkably, HSBC usually manages to acquire companies at the bottom of their earnings cycle and then skillfully turns them around. This rigorous process is accompanied by strong cross-selling efforts through integration of different business lines, such as consumer finance and commercial banking. Between 1998 and 2003, HSBC acquired 86 companies valued at $44.3 billion. With an average after-tax ROE of more than 15 percent, HSBC has operated at more than 4 percent above its cost of equity, on average, creating tremendous value. Capital markets rewarded this excellent fundamental performance with average annual TSR of 15 percent over the last five years. HSBC was the bestperforming bank in 2003, and the second best after Lehman Brothers for the past five years in terms of RRTSR. Understand acquisitions are a part of your daily business. Forethought and preparation allow the skillful competitor to drive hard bargains. Rigorously apply your successful business models to boost profitability. Stick to relatively small partners that always remain juniors. Leverage local partner platforms before investing in a big way.

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III. RANKINGS OF TOP PERFORMERS Large-Cap Companies

RRTSR rank 19992003 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 2003 12 1 14 21 28 4 40 35 22 20 43 30 27 11 39 37 26 31 3 19 5 23 29 6 32 33 45 25 2 41 49 44 17 13 38 8 7 50 15 18 24 10 47 34 16 48 9 42 46 36 Name Lehman Brothers HSBC Holdings Citigroup Bank of Nova Scotia Barclays Bank of Montreal The Royal Bank of Scotland Socit Gnrale ANZ Banking Group Merrill Lynch Royal Bank of Canada Morgan Stanley UBS ABN AMRO Deutsche Bank MBNA American Express Nomura Holdings Hang Seng Bank of America Westpac BNP Paribas Dexia Wells Fargo Washington Mutual Commonwealth Bank of Australia Santander Central Hispano Credit Suisse FleetBoston Toronto-Dominion Bank Fifth Third Bancorp National Australia Bank Nordea JPMorgan Chase HBOS Bank One U.S. Bancorp BBVA National City UniCredito Italiano The Bank of New York SunTrust BB&T Fannie Mae Wachovia Fortis Banca Intesa Lloyds TSB Freddie Mac Sumitomo Mitsui Financial Group Company Country USA GBR USA CAN GBR CAN GBR FRA AUS USA CAN USA CHE NLD DEU USA USA JPN HKG USA AUS FRA BEL USA USA AUS ESP CHE USA CAN USA AUS SWE USA GBR USA USA ESP USA ITA USA USA USA USA USA BEL ITA GBR USA JPN Segment IB UB UB UB UB UB UB UB UB IB UB IB UB UB UB CF CF IB UB UB UB UB UB UB MF UB UB UB UB UB UB UB UB UB UB UB UB UB UB UB TB UB UB MF UB UB UB UB MF UB M' cap '03 ($b) 21.0 172.7 250.4 25.8 58.3 20.7 87.0 38.6 24.0 55.3 31.4 62.7 81.0 38.9 48.4 31.8 62.0 33.5 25.1 119.5 21.7 56.9 20.1 99.6 36.1 28.0 56.5 43.6 46.0 21.9 33.6 33.9 21.9 74.8 49.9 51.0 57.4 44.1 20.6 34.0 24.1 20.1 21.1 72.9 61.9 26.0 25.8 44.8 40.5 30.9 RRTSR p.a. 11.7% 10.1% 10.1% 8.6% 8.5% 8.5% 8.3% 7.8% 7.4% 7.3% 6.9% 6.8% 6.0% 5.3% 5.2% 5.2% 5.1% 5.1% 4.9% 4.8% 4.7% 4.5% 4.4% 4.2% 4.0% 3.6% 3.1% 2.5% 2.3% 2.3% 1.9% 1.5% 1.4% 1.0% 0.5% 0.1% 0.1% 0.1% -0.1% -0.1% -0.2% -0.9% -1.0% -1.2% -1.5% -2.1% -2.3% -3.0% -3.2% -4.1% Performance 19992003 TSR p.a. 29.3% 15.0% 17.8% 17.5% 13.2% 15.3% 15.9% 20.3% 16.7% 13.4% 13.3% 12.0% 6.3% 5.1% 8.1% 9.9% 8.0% 14.1% 14.7% 10.0% 12.7% 10.8% 1.5% 10.6% 12.8% 10.2% 4.5% -0.3% 3.4% 13.1% 6.1% 8.7% 4.6% -1.6% 1.2% 0.7% 2.3% -1.7% 2.9% -0.7% -2.0% 1.3% 2.1% 2.1% -1.4% -11.9% -8.0% -6.9% -0.6% -12.6%

TSR ++++ +++ ++++ ++++ +++ ++++ ++++ ++++ ++++ +++ +++ +++ ++ ++ ++ ++ ++ +++ +++ +++ +++ +++ + +++ +++ +++ + + +++ ++ ++ + + + + + + + + -------

Risk + ++ ++ +++ ++ +++ ++ ++ +++ + +++ + ++ + + ++ ++ -+++ ++ +++ ++ + ++ ++ +++ ++ + + ++ ++ ++ ++ + ++ ++ ++ ++ ++ ++ + ++ ++ ++ ++ ++ + ++ ++ --

Market ---++ -+ ++ -++ --------+ -++ --++ ---++ ++ ---------

Rank 1 8 3 4 13 7 6 2 5 11 12 17 26 28 24 22 25 10 9 21 16 18 36 19 15 20 30 40 31 14 27 23 29 44 38 39 33 45 32 42 46 37 35 34 43 49 48 47 41 50

Biggest jump up From ('98-'02) 34 45 25 19 36 To ('99-'03) 15 29 10 5 23 Delta 19 16 15 14 13 Company Deutsche Bank FleetBoston Merrill Lynch Barclays Dexia From ('98-'02) 26 9 24 17 11 To ('99-'03) 49 31 40 32 26

Biggest jump down Delta -23 -22 -16 -15 -15 Company Freddie Mac Fifth Third Bancorp UniCredito Italiano National Australia Bank Commonwealth Bank of Australia

AM Asset manager CF Consumer finance IB Investment bank

MF TB UB

Mortgage finance Transaction bank Universal bank

RRTSR: Risk-adjusted relative total shareholder return TSR: Total shareholder return ----(++++) strongly negative (positive) Risk: Volatility of returns ---- (++++) very high (low) tive (positive) Market: Stock specific impact by overall market ---- (++++) strongly nega

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Mid-Cap Companies
RRTSR rank 19992003 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 2003 3 28 25 33 12 4 48 35 18 17 37 43 13 1 44 2 27 34 23 38 31 14 39 24 10 42 7 45 6 36 8 22 9 11 40 5 41 50 32 49 30 16 20 21 26 29 19 15 46 47 Name Golden West Financial Bear Stearns M&T Bank Sallie Mae SouthTrust Banco Popular Espaol United Overseas Bank Danske Bank Standard Chartered CIBC OCBC Bank Sumitomo Trust & Banking Franklin Templeton Investments Countrywide Financial Kookmin Bank UnionBanCal Charter One Financial State Street SEB Daiwa Securities Group DnB NOR Capital One Financial Nikko Cordial Svenska Handelsbanken (SHB) Marshall & Ilsley DBS Group Maybank Bank of Ireland Synovus Financial Northern Trust FreningsSparbanken Banco Ita Holding Financeira S.A. PNC Financial Services Standard Bank Group Mellon Sanpaolo IMI Regions Financial Corporations Allied Irish Banks Bradesco Charles Schwab KeyCorp Commerzbank Resona KBC Bank Almanij Mediobanca Comerica Amsouth Bancorp HVB Group Abbey National Company Country USA USA USA USA USA ESP SGP DNK GBR CAN SGP JPN USA USA KOR USA USA USA SWE JPN NOR USA JPN SWE USA SGP MYS IRL USA USA SWE BRA USA ZAF USA ITA USA IRL BRA USA USA DEU JPN BEL BEL ITA USA USA DEU GBR Segment UB IB UB CF UB UB UB UB UB UB UB UB AM MF UB UB UB TB UB IB UB CF IB UB UB UB UB UB UB TB UB UB UB UB TB UB UB UB UB AM UB UB UB UB UB IB UB UB UB UB M' cap '03 ($b) 15.7 8.0 11.8 17.0 10.9 13.6 12.2 16.7 19.4 18.1 9.1 8.6 12.9 14.0 12.6 8.4 7.7 17.4 9.9 9.1 8.7 14.2 10.9 14.6 8.7 12.7 9.1 13.2 8.7 10.2 10.4 10.8 15.2 7.9 13.8 18.9 8.3 13.6 7.9 16.1 12.3 11.7 14.3 14.1 9.9 8.4 9.8 8.6 12.2 13.9 RRTSR p.a. 11.6% 9.6% 7.9% 7.6% 6.3% 6.3% 5.9% 5.7% 5.6% 5.6% 5.1% 5.1% 5.0% 5.0% 5.0% 5.0% 4.9% 4.8% 4.8% 4.7% 4.5% 4.4% 4.3% 4.0% 3.3% 3.3% 2.9% 2.6% 2.4% 1.7% 1.7% 1.1% 1.0% 0.4% 0.3% -0.2% -0.4% -0.4% -0.5% -0.7% -0.8% -0.8% -1.1% -1.3% -1.5% -1.6% -1.8% -2.1% -3.3% -4.1% Performance 1999 2003 TSR ++++ ++++ ++++ ++++ ++++ +++ ++++ +++ ++ +++ ++++ ++++ +++ ++++ ++++ +++ +++ ++ +++ +++ ++++ +++ +++ ++ ++ ++++ ++++ ++ ++ + + ++++ + ++++ + + + ++++ -+ --------Risk ++ + +++ ++ ++ +++ ++ +++ + +++ ++ -+ + -+ ++ ++ ++ -++ --+++ ++ + ++ ++ ++ ++ ++ -++ ++ ++ + +++ ++ --++ --++ ++ ++ ++ ++ -+ Market + -+ + + -++ + -+ -++ -+ +++ -++ +++ --++ ---------TSR p.a. 28.2% 20.1% 15.1% 20.2% 15.3% 10.9% 20.1% 13.9% 9.6% 14.6% 18.1% 17.0% 11.0% 16.2% 31.7% 14.2% 11.8% 9.3% 11.2% 14.6% 17.6% 10.1% 14.7% 8.3% 7.6% 16.6% 15.9% 6.2% 6.1% 2.4% 4.8% 40.0% 3.9% 20.4% 0.7% -3.1% 2.1% 0.1% 32.7% -8.5% 2.9% -8.5% -4.4% -9.1% -9.1% -4.8% -0.5% -0.1% -18.6% -11.8% Rank 4 8 16 6 15 25 7 21 27 18 9 11 24 13 3 20 22 28 23 19 10 26 17 29 30 12 14 31 32 36 33 1 34 5 38 42 37 39 2 46 35 45 43 48 47 44 41 40 50 49

Biggest jump up From ('98-'02) 33 24 32 29 20 To ('99-'03) 10 5 13 14 6 Delta 23 19 19 15 14 Company CIBC SouthTrust Franklin Templeton Investments Countrywide Financial Banco Popular Espaol From ('98-'02) 7 21 9 6 5 To ('99-'03) 38 46 28 23 20

Biggest jump down Delta -31 -25 -19 -17 -15 Company Allied Irish Banks Mediobanca Bank of Ireland Nikko Cordial Daiwa Securities Group

AM Asset manager CF Consumer finance IB Investment bank

MF TB UB

Mortgage finance Transaction bank Universal bank

RRTSR: Risk-adjusted relative total shareholder return TSR: Total shareholder return ----(++++) strongly negative (positive) Risk: Volatility of returns ---- (++++) very high (low) tive (positive) Market: Stock specific impact by overall market ---- (++++) strongly nega

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Segment Ranking
Performance '99-'03 Segment RRTSR rank 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 RRTSR 5.0% 5.0% 1.0% 0.9% -0.7% 7.6% 5.2% 5.1% 4.9% 4.4% 11.7% 7.3% 6.8% 5.1% 4.3% 13.6% 5.0% 4.0% -1.2% -3.2% 11.4% 4.8% 1.7% 0.3% -0.2% 10.1% 10.1% 8.5% 8.3% 7.8% 6.9% 6.0% 5.3% 5.2% 4.8% 4.5% 4.2% 3.1% 2.5% 2.3% 1.9% 1.5% 1.0% 0.5% 0.1% 0.1% 0.1% -0.1% -1.5% -3.0% Name Franklin Templeton Investments T. Rowe Price Banca Fideuram Investors Group Charles Schwab Sallie Mae MBNA American Express AIFUL Capital One Financial Lehman Brothers Merrill Lynch Morgan Stanley Nomura Holdings Nikko Cordial Housing Development Finance Corporation Countrywide Financial Washington Mutual Fannie Mae Freddie Mac Investors Financial Services State Street Northern Trust Mellon The Bank of New York HSBC Holdings Citigroup Barclays The Royal Bank of Scotland Socit Gnrale Royal Bank of Canada UBS ABN AMRO Deutsche Bank Bank of America BNP Paribas Wells Fargo Santander Central Hispano Credit Suisse FleetBoston Fifth Third Bancorp National Australia Bank JPMorgan Chase HBOS Bank One U.S. Bancorp BBVA UniCredito Italiano Wachovia Lloyds TSB Country USA USA ITA CAN USA USA USA USA JPN USA USA USA USA JPN JPN IND USA USA USA USA USA USA USA USA USA GBR USA GBR GBR FRA CAN CHE NLD DEU USA FRA USA ESP CHE USA USA AUS USA GBR USA USA ESP ITA USA GBR Company M' cap '03 ($b) 12.9 5.9 5.8 6.3 16.1 17.0 31.8 62.0 6.9 14.2 21.0 55.3 62.7 33.5 10.9 3.5 14.0 36.1 72.9 40.5 2.5 17.4 10.2 13.8 24.1 172.7 250.4 58.3 87.0 38.6 31.4 81.0 38.9 48.4 119.5 56.9 99.6 56.5 43.6 46.0 33.6 33.9 74.8 49.9 51.0 57.4 44.1 34.0 61.9 44.8 TSR rank 99-03 1 2 4 3 5 1 4 5 2 3 1 4 5 3 2 1 2 3 4 5 1 2 3 4 5 4 2 6 3 1 5 12 14 11 9 7 8 15 20 16 13 10 23 18 19 17 24 21 22 25

Asset managers

Consumer finance companies

Investment banks

Mortgage finance companies

Transaction banks

Universal banks

RRTSR: TSR:

Risk-adjusted relative total shareholder return Total shareholder return

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

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Country Ranking
Performance '99-'03 Country RRTSR rank Australia 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 6 7 8 9 10 RRTSR 9.4% 7.4% 4.7% 3.6% 1.5% 8.6% 8.5% 6.9% 5.6% 2.3% 7.8% 7.5% 4.5% 4.1% 3.7% 5.2% 5.2% 4.2% -0.8% -3.3% -0.1% -0.2% -1.6% -2.3% -5.3% 5.1% 4.7% 4.3% -1.1% -4.1% 14.3% 6.3% 3.1% 1.7% 0.1% 6.0% 2.5% 1.7% 0.5% -5.5% 10.1% 8.5% 8.3% 0.5% -3.0% 10.1% 7.3% 6.8% 5.1% 4.8% 4.2% 1.0% 0.1% -1.2% -1.5% Name St. George Bank ANZ Banking Group Westpac Commonwealth Bank of Australia National Australia Bank Bank of Nova Scotia Bank of Montreal Royal Bank of Canada CIBC Toronto-Dominion Bank Socit Gnrale Natexis Banques Populaires BNP Paribas Entenial Union Financire de France Deutsche Bank DePfa Bank plc IKB Deutsche Industriebank Commerzbank HVB Group UniCredito Italiano Sanpaolo IMI Mediobanca Banca Intesa Capitalia Nomura Holdings Daiwa Securities Group Nikko Cordial Resona Sumitomo Mitsui Financial Group Banco de Valencia Banco Popular Espaol Santander Central Hispano Bankinter BBVA UBS Credit Suisse Julius Baer Vontobel Holding Liechtensteinische Landesbank HSBC Holdings Barclays The Royal Bank of Scotland HBOS Lloyds TSB Citigroup Merrill Lynch Morgan Stanley American Express Bank of America Wells Fargo JPMorgan Chase U.S. Bancorp Fannie Mae Wachovia Segment UB UB UB UB UB UB UB UB UB UB UB IB UB MF IB UB IB UB UB UB UB UB IB UB UB IB IB IB UB UB UB UB UB UB UB UB UB UB IB UB UB UB UB UB UB UB IB IB CF UB UB UB UB MF UB Company M' cap '03 ($b) 7.4 24.0 21.7 28.0 33.9 25.8 20.7 31.4 18.1 21.9 38.6 5.4 56.9 0.7 0.5 48.4 4.5 2.0 11.7 12.2 34.0 18.9 8.4 25.8 6.5 33.5 9.1 10.9 14.3 30.9 1.8 13.6 56.5 3.1 44.1 81.0 43.6 3.0 1.5 1.6 172.7 58.3 87.0 49.9 44.8 250.4 55.3 62.7 62.0 119.5 99.6 74.8 57.4 72.9 61.9 TSR rank 99-03 1 2 3 4 5 1 2 4 3 5 1 2 4 5 3 2 1 3 4 5 1 2 3 4 5 3 2 1 4 5 1 2 3 4 5 1 3 2 4 5 2 3 1 4 5 1 2 3 6 5 4 10 7 8 9

Canada

France

Germany

Italy

Japan

Spain

Switzerland

United Kingdom

United States

AM Asset manager CF Consumer finance IB Investment bank

MF TB UB

Mortgage finance Transaction bank Universal bank

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 countrys economy.

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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 750 stock-market-listed universal and specialized companies in the banking industry. The companies include all the major banking players and cover more than 80 percent of the worlds total market capitalization as of January 2003. BCG selected the sample for the banking industry.2 Six segments are distinguished The Sample Consists of More than 750 Companies in Different Regions and Segments in the sample: universal and diversified banks with a broad business portfolio; asset manag250 286 144 ers (providers of retail broker services and money management, including investments, Asset managers 26 Mortgage finance budgeting, banking, and taxes); companies 11 Consumer finance 5 companies 36 Transaction banks consumer finance companies Investment banks 68 Universal/diversified banks 609 (providers of personal financial services and credit card companies); investment banks (providers of capital markets and 50 18 7 corporate finance services); mortgage finance companies (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.
Sources: T.F. Datastream; BCG analysis.

Most of the historical capital market and fundamental data for the sample come from Thomson Financial DataStream. By choosing a different data provider (Thomson Financial Worldscope), the number of available historic, fundamental data could be doubled compared with last years report, thus providing a more precise and complete picture of the industry worldwide. Missing fundamentals for 2003 were replaced by IBES consensus forecasts if available. To get an undistorted picture of the past, the sample has been adjusted for large mergers and acquisitions.

Definitions and Methodology

Total Shareholder Return (TSR). Throughout the report, TSR stands for the change of stock prices and for gains by reinvestment of dividends paid in a period. Technically, it is the percentage change of the return index on that stock.
2

This is a significantly larger sample than the one we used for Creating Value in Banking 2003. As a result, some numbersmost notably percentage changesdo not tally with last years study.

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Risk-Adjusted Relative Total Shareholder Return (RRTSR). RRTSR is a performance metric developed by BCG for measuring the true capital-market performance of a company. Just like TSR, RRTSR measures shareholder returns as capital gains and dividends, but it adds two additional elements to TSR. First, RRTSR adjusts for the impact of the overall national stock market on the specific stock of the company. This feature is especially important in international performance evaluation. It allows, for example, comparing stocks in a bull market with stocks in a bear market. Therefore, RRTSR will be higher the smaller the impact of a positive overall market development iseither because the overall market performance is small or because the correlation of the stock with the market is small. Second, it is worth recalling that in several BCG studies, the performance measure relative total shareholder return (RTSR) has been successfully used to take the impact of different national markets into account. The new measure RRTSR takes the concept of RTSR one step further by additionally adjusting for risk. To be more precise, RRTSR calibrates for different stock-price volatilities to account for higher expected stock returns from stocks with greater risks; this allows, for example, comparing the returns of a company focusing on mortgage finance (with on average lower risk) with the returns of an investment bank (with typically higher average risk). Therefore, for any TSR of a specific stock, the RRTSR of the stock will be higher the lower the risk of the stock is. The formal definition of RRTSR for a stock A in a local market M at risk level

is as follows:

RRTSR (A, M; ) = ERAP(A; ) ERAP(M; ) N N N ERAP(A; ) = RAP(A; ) r = SR (A) N N f N

with

where ERAP is the excess of the risk-adjusted performance ( RAP ) of the ModiglianiModigliani model over the risk-free rate r , is the correlation between the returns of stock A and its ambient f domestic market M, and SR is the Sharpe Ratio of the stock or the market. The concept calibrates different risk levels at the uniform risk level . Although this allows us to express RRTSR in N meaningful units of returns, the ranking itself does not depend on the absolute level set for . 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 fundamental values, standard cash-flow projections based on companies current profitability and historical 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 longterm economic growth rate. These industry forces push profitability and equity growth to long-term levels irrespective of the starting levels being above the long-term levels (indicating fading of a superior performance) or below (indicating a recovery). The fade rates are held constant over time and are empirically derived from an optimization procedure fitting the values from the valuation model to the empirically observed market capitalization. The absolute expectation premium is defined as the difference between market capitalization and the fundamental value, whereas expectation premium is simply the share of the absolute expectation premium on the total market capitalization. Thus, expectation premiums might very well be negative.

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Total Business Return (TBR). TBR is calculated as change in fundamental value over two years plus free cash flow to shareholders. It therefore measures on a percentage basis value creation by a company using fundamental data only. Added Value on Equity (AVE) and Delta Added Value on Equity (DAVE). AVE measures the economic income of a bank. DAVE Integrates Profitability and Growth AVE is calculated by multiplying the spread of ROE over COE with the amount of equity 1 Increase in profitability 2 1 + 2 Profitable growth capital of the bank. AVE therefore measures (in absolute units) what has been earned in Return Return excess of the opportunity cost Return Return Return of equity capital. The difference Cost of Cost of Cost of capital capital capital between the AVEs of two successive years is DAVE. Since a Equity Equity Equity Equity Equity change in profitability and a change in the amount of equity Added Value on Equity (AVE ) capital have an impact on DAVE, this performance metric DAVE = AVE AVE integrates profitability and growth simultaneously.
2 1
2 1

1,2

1,2

1 1

2 2

1 1

1 1

2 2

1 1

Source: BCG value management.

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 calculated over two years, on a weekly basis.

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