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Fis strategic insights vol 8 june 2012


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Fis strategic insights vol 8 june 2012

  1. 1. WWW.FISSTRATEGICINSIGHTS.COM VOLUME 8 • JUNE 2012Innovation and Disruption: IN THIS ISSUETwo Sides of the Same Coin • Innovation and Disruption: Two Sides of the Same Coin By Fred Brothers • P2P Innovation for EXECUTIVE VICE PRESIDENT, STRATEGIC INNOVATION Your Bottom Line Many of you saw me speak about disruption and • Financial Profiles innovation at one of FIS’ three recent client conferences. of High-performing I was really pleased by the number of our clients that Community Banks stopped me after the presentations to either agree or • Prepaid Only vs. Prepaid disagree with my comments, and to applaud this year’s and Gift Consumers conferences as the best they’ve attended in some time. I agree that InfoShare 2012 in Orlando, FIS Client Conference 2012 in Milwaukee, and the FISInternational Conference in Dubai were all better than ever. I also believe yourcandid feedback is critical for FIS™ to make ongoing improvements in our client conferences and the presentations of FISexecutives who speak at the events. Please continue letting us know how we’re doing.Innovation and disruption represent “two sides of the same coin.” When technology evolves or a market changes, ifyou’re the incumbent (holding that account, processing that transaction, serving that customer need, etc.) you’re likely toview the change as a disruption, and potentially a threat to your business.Conversely, if you’re the outsider (to that account, transaction, customer, etc.), you’re much more likely to view the samechange as innovation and a potential opportunity – to take market share, hurt your competitors, create more value, wincustomers, raise prices, etc.I don’t believe in “fighting big, macro market trends” (some call it “swimming against the current”). Either way, the resultis usually the same – the trend wins; those fighting it don’t. Smart incumbents (and their partners) strive to understandthe big, macro market trends, then figure out how to embrace trends and leverage market shifts to their (and theircustomers’) advantage.They see both sides of the coin, which allows them to assess both upsides and downsides and plot a course correction toleverage change and not squander resources on a losing market tactic or business model.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 1
  2. 2. FIS Strategic InnovationThe FIS Strategic Innovation Group’s role is to focus on both sides of the coin – disruption and innovation. I’ll explain thisfurther but, first, let me be clear about what we don’t do. For the most part, we don’t focus on “sustaining innovations,”which are the logical evolution and improvement of our existing solutions. FIS has many very capable business unitleaders and product managers who already are doing a great job of improving our existing solutions based on theirknowledge of the market and lots of input from their clients.Instead, what my team focuses on is “discontinuous” innovations – the transformational technologies and approaches thathave the potential to disrupt existing solutions and/or create significant opportunities for those nimble enough to embracethe change and capitalize on the opportunity. These could be FIS solutions. They could be someone else’s solutions.At a high level, the Strategic Innovation Group:1. Monitors innovations and disruptions, both inside and outside of banking and payments2. Envisions where the banking and payment industry will be in the intermediate future (2 – 4 years)3. Identifies the industry’s future threats, opportunities, growth engines and competitive necessities4. Ensures that FIS offers market-leading solutions to mitigate those threats and capitalize on those opportunities, so our clients can remain successful and competitive in their markets for their customers.I’ll give you some examples of the first three stages; then I’ll bring those of you who didn’t catch the conferencepresentation up to speed on what FIS is doing to address the fourth stage.Monitor Innovations and DisruptionsLet’s look at three examples of change in the financial industry, which can be viewed as either disruptions or innovations,depending on your perspective.Disruption of branches, rise of digital channelsFew would argue that branch traffic has declined during the past decade while digital channels have become veryimportant. What’s news is that we hit an inflection point in consumer adoption around 2010. According to an ABAtracking (annually recurring) survey, the Internet as a preferred banking channel soared between 2010 and 2011 for allage groups. In 2009 only 11 percent of 55-and-older consumers said they prefer the Internet as their primary bankingchannel. By 2011, that percentage rocketed to 58.1FIS’ February 2012 consumersurvey found that online banking Figure 1: Online banking has reached high levels of penetration among all generationspenetration remains higher Online and Mobile Banking Transactions in Past 30 Daysamong younger generations. 90% 6.0 90% 6.0More than half (55 percent) Average mobile transactions Mobile banking penetration Average online transactions Online banking penetration 80% 80%of respondents 65-and-older 70% 5.0 70% 5.0participate in online banking and, 60% 4.0 60% 4.0on average, they make 4.1 online 50% 50%banking transactions a month – 3.0 3.0 40% 40%not much less than the younger 30% 2.0 30% 2.0Baby Boomer cohorts (Figure 1). 20% 20% 1.0 1.0 10% 10% 0% 0.0 0% 0.0 Gen Y Gen X Young Old Matures Gen Y Gen X Young Old Matures Boomers Boomers Boomers Boomers Source: FIS survey, February 2012; n = 3,205FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 2
  3. 3. In contrast, mobile banking is still largely a tool of Gen Disruption of free checking, rise of prepaid andY with a 34 percent penetration and averaging 1.5 alternative financial servicesmobile banking transactions a month. We expect this to Directly related to the disruption of the banking revenuechange rapidly as smartphones become ubiquitous and model is the disruption of free checking and the rise ofmore financial institutions provide easy-to-use mobile prepaid cards and alternative (and differently regulated)banking and payment solutions. According to the most financial services. According to’s 2011recent figures from ComScore MobiLens, 12.7 million Checking Account Survey (of the five largest banksconsumers used a mobile banking app in June 2011, up and five largest thrifts in the top 25 U.S. markets), onlyan astounding 45 percent from six months prior to that.2 45 percent of noninterest accounts are now free – anMobile is growing so fast that we measure changes in incredible 31 percentage point decline from the peak ofconsumer adoption in months instead of years. 76 percent free checking in 2009.3Disruption of the banking fee model, rise of alternative At the same time, prepaid card use rose significantly. Inincome sources 2011 prepaid card use rose 18 percent year-over-year toThe effect of Durbin, NSF fee reform, and a fed funds reach 13 percent penetration of the U.S. adult population.rate at 0 percent has been to fundamentally disrupt the And, the percentage of adults that has checking accounts,banking fee model and how our industry funds the cost savings accounts, credit cards or debit cards has declinedof maintaining checking accounts. Just as local retailers roughly 11 percentage points since 2010 according toare struggling in an Internet-shopping world to get Javelin.4 General purpose reloadable prepaid cards areconsumers to pay full price, bankers are struggling in a functioning as checking accounts for an increasing numberpost-regulatory change market to get consumers to pay of consumers. The Javelin survey also points out that onlyfor their checking accounts. The disruption of the banking 27 percent of prepaid users obtained the prepaid cardfee model requires that we find new sources of income they use most often from a bank. More commonly, they’refor financial institutions. One opportunity that I believe getting them from retailers (37 percent). Other commonwill become an industry norm in the next few years is sources include employers (14 percent) and governmentto monetize the data in your systems in ways that your agencies (7 percent). If you’re a bank the majority of thecustomers will permit. prepaid action (and revenue) is occurring outside of your domain.On a recent flight I pulled down the tray table and therewas advertising covering every square inch of the tray Identify Banking and Payment Industry’stable. To be honest, having advertising staring me in the Future Growth Enginesface on a plane was initially a little off-putting to me. Butthen I thought about the struggles the airline industry In this era of regulatory mandates around fee structures,has faced in the past few years – intense competition, banked but underserved consumers are the segment ofincreasing regulation, downward pressure on income, our customers that are most accustomed to paying feesincreasing costs and major technology shifts. That sounds for financial services. My nephew is a good example. Hea lot like the banking industry, doesn’t it? In the end, the doesn’t have a checking account or credit card with atray table ad didn’t matter much to me. The flight took off bank because he hasn’t had the chance to become crediton time, they brought me a cold Diet Coke and we landed worthy. But, he’ll pay $5.00 to cash his paycheck andsafely and on time – these are the criteria I use to measure a fee to reload his prepaid card. My family’s assets aremy satisfaction with an airline. The more I thought about somewhat larger than my nephew’s, but the only businessit, the more the airline’s incremental revenue from that we maintain with our local bank is a checking account, andtray table ad looked like a pretty smart tactic – instead I refuse to pay any fees. We have a great credit score andof charging me for my Diet Coke (which would have more assets, yet our primary checking account providerreally been off-putting to me). Their strategy of seeking probably loses money on our relationship because most ofalternative sources looked very … well … strategic. our assets and loans are held at other institutions. Instead of trying to get more business from me, maybe my bank should be talking to my nephew.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 3
  4. 4. Robust services for the banked but underserved represent a tremendous futuregrowth engine. Such services include: Potential Growth Engines FIS Strategic Innovation• Payday lending is evaluating:• Prepaid cards• Money transfer services including both domestic and international P2P and • Alternative banking money transfer • Next-gen authentication• Prepaid mobile phone top up credits • Data analytics • Leveraged marketingAnother future growth engine is innovation that facilitates Web transactions • Payday lendingfor consumers. BillMeLater allows consumers to finance online purchases • Small business electronicimmediately vs. waiting on bank or merchant financing. Web transactions invoice presentmentare rising rapidly driven by site improvements, free shipping promotions, and paymentflash sales and daily deals, and growth in smartphones and tablets. Forrester • Social media managementprojects a 45 percent growth in online spending – mostly driven by peoplespending more online – between 2012 and 2016.5Mobile banking and mobile wallet represent key growth engines. Top-of-wallet status becomes even more challengingto achieve in the virtual wallet than the traditional one. If you haven’t checked out the FIS mobile wallet, you should. we’re evaluating many innovations so that our clients can reap the benefits of FIS’ huge annual investmentin innovation, I’ll mention just one more for now: Data Analytics will help our clients dramatically improve the return ontheir marketing investment, by tailoring specific offers to specific households and individuals. Data Analytics deepensrelationships with customers by identifying what products, services and ancillary offers such as merchant-funded rewardsare most likely to resonate with specific customers.I am consistently amazed that in this mobile and Internet interconnected world − one in which Google knows what wantbefore you finish typing it, and Facebook knows almost everything about everyone, and Amazon can tell you what youshould want even if you don’t know you need it – that banks and credit unions are still spending marketing dollars onroadside billboards and statement stuffers.At most financial institutions, the Marketing Department is the last bastion of unoptimized, legacy spending. Mostare still using the same marketing methods and delivery channels that were successful in the 1990s. Non-banks andnon-credit unions have revolutionized marketing through the use of data, analytics, targeted offers and one-on-onemarketing. If financial institutions don’t embrace the same, we risk being marginalized sooner than we think.Ensure FIS Offers Innovative and Competitive SolutionsSeveral ways FIS and the Strategic Innovation Group are investing in innovative and competitive solutions include:Forming strategic partnerships − FIS partners selectively with early-stage growth companies that are pouring all of theirefforts and talents into a single, fast-growth, innovative solution. These partnerships allow FIS and its clients to maintainthe necessary agility to move with the market as innovations evolve, while offering you a fully-vetted solution and thestrength of contracting with FIS instead of less-capitalized startup.Making strategic investments − FIS will occasionally take a minority interest in companies with which we’ve formedstrategic partnerships. We will invest in companies with healthy outlooks but lacking adequate funds to fuel growthquickly enough to produce the innovation we want for our clients. Sometimes we also will take a board seat to helpguide the evolution of the company and ensure that you get the level of quality, consistency and innovation you expectfrom FIS.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 4
  5. 5. Making selective acquisitions − Although FIS announced earlier this year that we won’t be doing multi-billion dollaracquisitions in the next few years of FIS’ evolution, we will continue to make smaller acquisitions to obtain solutions,talent and capabilities we need to help our clients succeed. We will invest as much as several hundred million dollarsannually if we believe that investment supports our clients’ ability to thrive.Reinvesting internally − The Strategic Innovation Group partners closely with our technology team and business units toensure our internal reinvestment of capital is aligned with our strategic partnerships, strategic investments and selectiveacquisitions. In other words, we are investing in the innovation that will strengthen your firms against disruptive forces inthe landscape and level the playing field. We do this because we know that the only way FIS will succeed is if we helpour clients to succeed.Wow, this turned out to be a significantly longer article than I usually write, but this is a really important topic for ourclients, our industry and our company. Thanks very for reading on to this point.In closing, I want to reiterate that we’re working hard to figure out where this industry is going and to ensure that youhave the solutions you need to succeed − both now and in the future. We’re spending our investment dollars so youdon’t have to.And as always, thank you for your business, for your partnership, and for your friendship with FIS.1 ABA survey with Ipsos Public Affairs, September 20112 comScore press release, “Mobile Banking App Usage in the U.S. Increases 45 Percent from Q4 2010,” 26 October 20113, “2011 Checking Account Survey,” August 20114 Javelin Strategy & Research, “Prepaid Cards and Products in 2012: Enabling Financial Access for Underbanked and Gen Y Consumers,” April 20125 Forrester Research, “U.S. Online Retail Forecast, 2011 to 2016,” 27 February 2012FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 5
  6. 6. P2P Innovation for Your Bottom Line By Nancy Langer DIVISION EXECUTIVE, ePAYMENTS P2P Opportunity for Financial Institutions The opportunity for financial institutions to capture revenue in P2P payments is enormous – 11 billion transactions (roughly 97 per household annually) in 2011 according to Aite.1 Two-thirds of those transactions are currently paper-based – 51 percent cash and 17 percent paper checks. Migrating paper-based payments to electronic payments to capture “the last mile” of electronic connectivity is not without challenges. From the consumer’s perspective, convenience is a key factor in P2P payment preference. FISresearch conducted with 3,205 consumers earlier this year shows greater preference for paper checks than cash for P2Ppayment. Although more than half of P2P transactions are cash, consumers would prefer to pay via paper checks (64percent) vs. cash (56 percent) when the payment method is available to them (Figure 1). For some consumers it’s moreconvenient to write a check than run to the ATM for cash.There are some current barriers to P2Pgrowth – namely the user experience not Figure 1: Convenience is a key factor in P2P payment preferencebeing well integrated into the broader Payment Methods for Paying People such as Contractors, Household Help,payments and online offering and the lack of Delivery People, Babysittersinteroperability and network structure. Despite 90% 90% Prefer (base = available)these barriers, we believe that electronic P2P 80% 80%will continue to grow rapidly. The expansion 70% 70%of mobile banking and integration of P2P with 60% 60%online and mobile banking financial serviceswill deliver convenience to both payer and 50% 50% Availablepayee. We’ve seen how the convenience of 40% 40%mobile remote deposit capture (RDC) has 30% 30%dramatically reduced branch visits for RDC 20% 20%users. The hardware is in place for largenumbers of consumers to make P2P electronic 10% 10%transactions either online or through their 0% 0%mobile phones. Smartphone penetration eked Paper checks Cash Credit Debit cards Online Gift cards cards payment Money order Prepaid cardsinto the majority (50.4 percent) of mobile service Source: FIS research, February 2012; n = 3,205phone subscribers this spring according toNielsen.2 Now, P2P networks need to becomethe convenient choice for consumers and smallbusiness payees.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 6
  7. 7. Current P2P LandscapeWith an estimated more than 100 million active users, PayPal™ has dominated the P2P and person-to-business (P2B)landscape. No other player – PopMoney®, MasterCard® MoneySend™, Visa® Money Transfer – comes close to thenumber of users of PayPal. According to a recent article in American Banker, PayPal controls 90 percent of the currentP2P market.3 That said, much of PayPal’s base is E-commerce rather than person-to-person. The landscape is changingand barriers are primed to be broken down.The large banks are more serious than ever about getting into the P2P business, which will dramatically boost consumerusage. Send and Receive Money from the clearXchange joint venture of Wells Fargo, Bank of America® and JPMorganChase allows customers of consortium banks to send and receive money to each other without exchanging account orother banking information after they’ve initially cleared a security process during registration. This will improve ease ofuse among consumers who bank with those financial institutions.Other players that will change the landscape include mobile players such as telecom consortium Isis, solutions that allowpayees to accept card payments such as Square, social media and virtual currency companies such as Facebook andZynga, and perhaps even niche apps such as Bump Pay, which enables two smartphones to transfer data including howmuch money someone wants to send to someone’s PayPal account by “bumping” mobile devices together.Evolution of the P2P Landscape: Integration and InteroperabilityTo date, the user experience for P2P has beensuboptimal because P2P offers are generally Figure 2: The effect of the network accelerates usage andstand-alone solutions and not significantly registry valueintegrated into other types of online payments.They also lack network leverage andinteroperability among networks. My belief is Financial Institution A Financial Institution Cthat the only way P2P will migrate from paper to Sender Senderelectronic payments among the mass market isthrough interoperable networks among the big Recipient RecipientP2P players.FIS has addressed the issue of integration of P2P P2Pwith other types of online payments by creating Consumeran FIS money movement portal. This portal will Registry Financial Institution B Financial Institution Dinclude the option to pay people electronically. Sender SenderThe P2P build-out is in progress for delivery laterthis year. Our bills and payments offer will includeoptions to pay bills, make expedited payments, Recipient Recipientpay people, transfer money to another financialinstitution and move money internationally. And,it will be FI-branded.FIS also is building its own registry of senders and receivers among various financial institutions. The central point of P2Pis what we call the registry that holds receiver and sender preferences in a secure environment (Figure 2). The sender atone financial institution is able to transfer money easily and securely to a recipient at another financial institution that ispart of the network. As the registry grows the number of member financial institutions, it becomes more interoperableand the registry value increases.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 7
  8. 8. A key part of FIS’ strategy is to achieve Figure 3: Interoperability among networks creates a P2P Super Network interoperability with the other networks including clearXchange and others that could evolve, thereby creating a P2P super network (Figure 3). FIS’ commitment is to maintain an open network that will allow for maximizing connectivity with other networks. This will allow Wells Chase the majority of banked customers to easily and National ClearXchange securely send and receive money to each other FIS Banks Network Network B of A through their own financial institutions. Credit Regional Unions P2P Super Déjà vu Banks Network (prospec ve Network par cipants The non-FIs have invaded the P2P space in a Credit National Banks Unions illustrated) similar way we observed during the 1990s with the entry of Microsoft® and Yahoo® into online Other Networks Regional banking. But financial institutions prevailed Banks long term. Fast forward to the current crowded field of P2P players. PayPal is a threat because the companyunderstands transactions and fraud and has the infrastructure in place to serve the mass market – and it’s clearly in theprocess of significantly expanding its payments services beyond the core P2P payment offering that was launched in1998. PayPal is good at identifying gaps between old models and current consumer needs and filling those gaps. Rightnow the majority of its funds flow through checking accounts (ACH) and credit cards and PayPal could be considered“co-opetition” as opposed to competition.Although my belief is that financial institutions will again succeed against the plethora of E-commerce competitors, weneed to pay attention to all of them. We need to learn from them and figure out how to leverage our assets aggressivelyto fill gaps in the customer experience. We need to reassess models that may not be optimizing opportunities in today’s“new normal.”In closing, I’ll leave you with these thoughts as your institution launches (or continues) its P2P payments journey.Leverage your institution’s strengths and credibility for safety and soundness. This is one instance when being a regulatedinstitution is a good thing because of the clear and visible consumer protections that result. Consumers get it and mostof them prefer to initiate and receive payments through their banking provider.Make sure your institution controls the offer’s branding and that the P2P network you join is fully interoperable. Inaddition, your P2P offering must be tightly integrated with your online and mobile banking offerings and you’ll need toprovide customers multiple send and receive options (e.g., ACH, card, check, PayPal account).And finally, be willing to innovate and experiment; get practical experience. The next 12 – 24 months promise to be abreakthrough period for P2P payment pilots and rollouts by financial institutions. Consumer awareness and interest isgoing to spike dramatically and institutions that get involved now will be the ones that realize the greatest customeradoption and utilization.1 Aite Group Survey of 1,036 U.S. Consumers, August 20112 Nielsen, “America’s New Mobile Majority: a Look at Smartphone Owners in the U.S.” March 20123 American Banker, “Wells, B of A and JPM Look to Shake Up P-to-P Payments.” 25 May 2012FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 8
  9. 9. Financial Profiles of High-performingCommunity Banks By Paul McAdam SENIOR VICE PRESIDENT, RESEARCH AND THOUGHT LEADERSHIP In my recent articles I’ve explored various facets of community bank performance, mainly based on the characteristics of their customer bases. This month’s article profiles high- performing community banking organizations and specifically examines the financial metrics that differentiate the elite performers from the rest of the pack. Industry Profitability Rebounding, but Not as Much for Smaller Banks After a couple of very tough years, banking industry profitability rebounded nicely in 2010 and 2011 (see Figure 1). The positive upward trend continued in 2012 as the FDIC recently announced that first quarter commercial bank profits topped $35 billion. If this momentumholds, the industry will generate full-year 2012 profits of approximately $140 billion – nearly on par with record industryprofits attained in 2006.But a thorough examination of this industry Figure 1: Industry profitability is rebounding, but still under pressuredata reveals that a swelling portion of post-recession profits have been generated bythe largest U.S. banks. Pre-recession, the U.S. Commercial Bank Profitabilitytop 10 banks generated an increasing share (share of industry profit from top-10 and all other banks) $160of industry profits, peaking at 53 percent in $1402007. What you don’t see in this chart is thatin 2008 and 2009 the top 10 banks remained $120 50%profitable as a group – albeit barely – while $100 55% 37% All banksthe banks below the top 10 collectively 56% $ Billions $80 47% 2008 – 2009lost money. As the economy improved, the 30% Non top-10 $60 banksshare of industry profits generated by the Top-10 bankstop 10 accelerated to 70 percent in 2010 $40 50% 63% 44% 45% 53% 70%and moderated to 63 percent in 2011. $20Conversely, from 2004 − 2007, banks with $-assets of less than $1 billion generated 11 $(20)percent of industry profits on average. In 2004 2005 2006 2007 2008 2009 2010 20112011 they generated only 6 percent. Source: FIS analysis of data from FDIC Statistics on Depository Institutions (SDI)FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 9
  10. 10. While the profitability of community banks Figure 2: Community bank profitability rebound lags larger banks; the(assets of less than $1 billion) as a whole certainly efficiency ratio gap has widenedimproved post-recession, their average return onassets (ROA) has not rebounded as significantly Return on Assets Efficiency Ratio (by asset size) (by asset size)as that of larger banks with assets exceeding $1 80%billion (Figure 2). In contrast, the average ROA of 1.50%community banks fell just short of larger banks’ 1.25% 70%average ROA pre-recession and slightly exceeded 1.00%it during the downturn from 2007 – 2009. So, 60%industry profit dynamics have clearly shifted. The 0.75%question is whether the shift will be permanent. 0.50% 50%We see a similar pattern for efficiency ratios. The 0.25%gap between community and larger banks was 0.00% 40%fairly constant through 2007 at 7 − 9 percentage 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 - 0.25%points (Figure 2). The efficiency ratio gap widened Under $1Bduring the recession to 20 percentage points in Over $1B2009 as the revenue-generating efficiency ratio Source: FIS analysis of data from FDIC Statistics on Depository Institutions (SDI)of community banks declined while that of thelarger banks actually improved for a couple years.Post-recession, the efficiency ratio gap between Figure 3: Some community banks have performed exceptionally well;community and large banks remains wider than it yield on loans is a key driverwas pre-recession. Return on Assets Yield on Loans (banks with assets less than $1 billion) (banks with assets less than $1 billion)High-performance Community Banks 2.5% 9%While the financial rebound of the community 2.0%bank market has lagged, it is absolutely possiblefor smaller banks to outperform the market as 1.5% 8%shown through extensive analysis of an FIS™ 1.0%database derived from eight years of bank Call 7% 0.5%Report data compiled by SNL Financial. The FISdatabase includes 4,380 banks with assets of less 0.0% 2004 2005 2006 2007 2008 2009 2010 2011than $1 billion. We divided community banks into 6% -0.5%three tiers of performance – high, mid and low High Performingperforming – based on ROA. The high performers -1.0% Mid Performingcomprise the top 10 percent of community banks 5% -1.5% Low Performing 2004 2005 2006 2007 2008 2009 2010 2011based on ROA, the mid performers represent Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less thanthe middle 80 percent, and the low performers $1 billion. n = 4,380represent the bottom 10 percent.On average, the high performers have consistently achieved an ROA above 2 percent. The mid performers’ average hasbeen in the 1 percent range. The low performers were generating a sub-standard average ROA before the recession,which has been in negative territory since 2008 (Figure 3).FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 10
  11. 11. Our analysis examined statistical relationships between roughly two dozen bank financial metrics and ROA duringthe eight-year period to determine the metrics that are most strongly associated with ROA and did the best job ofdifferentiating high from low performers. Of no surprise, metrics associated with credit quality were most predictive ofbank performance. Credit quality can make or break a bank – particularly in the economic environment of the past fewyears. But beyond credit quality we uncovered several additional metrics that deserve special attention.Yield on loans is a key differentiator of performance among the three bank segments (Figure 3). On average, allcommunity banks’ loan yields plummeted during the recession, but high performers did a better job of managing theirloan portfolios. Analysis revealed several key actions taken by the high performers to preserve loan yield.• They consistently maintained higher loan pricing.• They had more-diversified loan portfolios. Higher performers tended to have fewer commercial real estate and construction and land development loans. However, they had consistently higher concentrations in traditional commercial and industrial loans, farm real estate and farm productions loans, and consumer loans. And the high performers were not over weighted in residential real estate.• High performers were more effective in shifting and rebalancing their loan portfolios as the recession hit – for example shifting out of commercial real estate and into agricultural.Because of higher loan yields, the high-performing community banks were able to maintain net interest margins 50 − 100basis points higher than lower-performing community bank peers (Figure 4).How community banks managed their depositportfolios was also a key differentiator between Figure 4: The higher performers have maintained strong margins whilehigh performers and others. As the recession hit, effectively managing operating expenseshigh performers more quickly shifted their mix of Net Interest Margin Operating Expense Ratiodeposits into core deposits and DDA balances. (banks with assets less than $1 billion) (banks with assets less than $1 billion)This effective management of deposit interest 5.0% 4.0%expense helped them maintain an impressive NIMin the face of declining loan yields.As you can see in the Operating Expense Ratio 4.5% 3.5%chart (operating expenses divided by averageearning assets) on the right side of Figure 4, highperformers did a much better job countering 3.0% 4.0%the downward trend in net interest margin and High Performingfee income by managing operating expenses. Mid PerformingAs the recession took hold in 2008, they did Low Performingan exemplary job of moving quickly to keep 3.5% 2.5% 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011expenses under control. In contrast, the operating Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less thanexpense ratios of the low performers climbed as $1 billion. n = 4,380the economy declined.FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 11
  12. 12. Figure 5 profiles the 2011 operating expense Figure 5: High-performing banks realized better operating expenseratios of the three bank segments. Again, we ratios across the boardsee that the high performers surpassed theirpeers across the board in managing expenses. 2011 Operating Expense Ratios (banks with assets less than $1 billion)While the differences in the salary and benefitsand occupancy and fixed assets expenses of the 3.83%three segments seem modest at first glance, basis 3.22%points matter significantly in banking. The typical 2.91% 1.47% Other Operating Expensescommunity bank in our analysis had earning 1.08% 0.94% Occupancy and Fixed Assetsassets of approximately $200 million. At this asset 0.48% Salary and Benefits 0.40%level the 16 basis point difference between the 0.34%high- and mid-performing banks in salary andbenefits and occupancy and fixed assets amounts 1.63% 1.73% 1.85%to a $320,000 expense advantage for the high-performing banks. High Mid Low Performing Performing PerformingThe category of “Other Operating Expenses” iswhere high-performing banks gained their clearest Source: FIS analysis of bank Call Report data from SNL Financial. Banks with assets less thanadvantage. This category includes items such as $1 billion. n = 4,380data processing, telecommunications, marketingand consulting and advisory expenses – and thehigh-performing banks excelled in managing all of them. But expenses associated with loan collections and real estate ownedaccount for the biggest difference between the segments in this “Other” category. High-performing banks maintainedsignificantly lower loan delinquencies and charge offs and gained additional operating expense advantages as a result.What’s becomes clear in examining a variety of metrics that separate high performers from their peers is that high-performing banks managed the bank for growth and did not simply try to save their way to prosperity. From 2004 −2011, the high-performing banks experienced an average annual increase in operating expenses of 3.9 percent whileoperating expense of the mid-performing banks grew by an average of 3.1 percent.A Culture of PerformanceHow did the high-performing community banks consistently accomplish these impressive results? Clearly thesecompanies didn’t perform this well by accident because they performed well across all of the key financial metrics weanalyzed. We can assume they have strong leadership and performance-based cultures. But the opportunity we’ve hadto speak with executives from high-performing community banks within the FIS client base in recent months providesinsights into key drivers of high performance. Such banks are very good at:• Focusing the entire organization on a highly visible and easy-to-understand strategy• Driving accountability throughout the organization• Simultaneously managing multiple challenges• Formulating timely reactions to changes in customers and competition• Introducing innovation in response to market demand• Managing operations that are flexible and able to respond to change quickly• Maintaining high levels of quality control with less variability in processesThey leveraged these skill sets to overcome persistent challenges facing community banking organizations during thepast several years. We can all learn from these institutions.We’ll continue to explore themes of differentiation and high-performance banking in future newsletter editions. If youhave any thoughts or comments regarding bank performance that you’d like to share, you can feel free to contact meat STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 12
  13. 13. PREPAID ONLY VS. PREPAID AND GIFT CONSUMERS FIS research conducted in February 2012 with 3,205 consumers about their payment methods revealed two distinct segments based on payment method usage. The two segments − Prepaid Only and Prepaid and Gift users − are very different from each other demographically, attitudinally and behaviorally. Each segment will require specifically targeted appeals to gain ground against competitive payment methods. By Mandy Putnam DIRECTOR, RESEARCH AND THOUGHT LEADERSHIPFIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 13
  14. 14. PREPAID MARKET The Prepaid market is divided into two segments − Prepaid Only users and Prepaid and Gift users: • Prepaid Only users did not use gift cards in the past 30 days while Prepaid and Gift users employed both payment types. Prepaid and Gift users outnumber Prepaid Only users by nearly 2-1 but Prepaid Only users utilize pre- paid cards nearly twice as much (5.0 transactions in past 30 days) as Prepaid and Gift users (2.9 trans- actions in past 30 days). As a result, the usage volume − transactions times number of users − is roughly equivalent for both segments. This calculation does not take into account transaction amounts, but does underscore the significance of both segments. Prepaid Card Usage (Past 30 days) Prepaid Only Both Gift and 4% Prepaid Card Usage Prepaid (Number of times) 8%* 5.0** Neither Gift Gift only nor Prepaid 25% 63% 2.9 Prepaid Prepaid and Gift * Read as: 8% of the sample used both gift and prepaid cards in the past 30 days; n = 3,205 ** Read as: on average Prepaid Only users used a prepaid card 5.0 times in the past 30 daysFIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 14
  15. 15. CONSUMERS WHO USED PREPAID CARDS BUT NOT GIFT CARDS WITHIN THE PAST 30 DAYS ARE DISTINCT FROM CONSUMERS WHO USED BOTH PREPAID AND GIFT CARDS: • Prepaid Only users are twice • The majority of Prepaid and Gift • In sharp contrast, Prepaid as likely to be unbanked and users are members of Gen Y Only users are poorer, less underbanked (no deposits or or Gen X, homeowners and educated and less likely to investment accounts other than employed fulltime. More than be employed fulltime. checking) than Prepaid and four in 10 have kids at home and Gift users. college degrees. Nearly four in 10 have annual household incomes exceeding $30,000. Prepaid Only Prepaid and Gift Unbanked 23% Unbanked 10% Underbanked 16% Underbanked 8% Gen Y 21% Gen Y 28% Gen X 23% Gen X 28% Younger Boomers 26% Younger Boomers 21% Older Boomers 20% Older Boomers 14% Matures 10% Matures 9% Income <$30k 47% Income <$30k 21% Homeowner 50% Homeowner 67% Children 33% Children 41% College grad 33% College grad 44% Employed fulltime 47% Employed fulltime 61%FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 15
  16. 16. LACK OF ACCESS VS. EXCESS CONSUMERS WHO USED PREPAID CARDS BUT NOT GIFT CARDS WITHIN THE PAST 30 DAYS HAVE LESS ACCESS TO NON-CASH PAYMENT METHODS THAN THOSE WHO USED PREPAID AND GIFT CARDS: • Prepaid Only users are one-third (34 percent) less • More likely to be unbanked, Prepaid Only users likely to use credit cards and 12 percent less likely are far less likely to use paper checks to pay. to use debit cards than Prepaid and Gift users for in-person purchases. Payment Methods Used for In-person Purchases (Past 30 days) Prepaid Only Prepaid and Gift Cash 91% Cash 95% Debit cards 65% Debit cards 73% Credit cards 45% Credit cards 67% Paper checks 37% Paper checks 64% Mobile payments 9% Mobile payments 18% Contactless payments 7% Contactless payments 15%FIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 16
  17. 17. USAGE OF ALTERNATIVE FINANCIAL SERVICES DIFFERS SIGNIFICANTLY BETWEEN PREPAID ONLY AND PREPAID AND GIFT USERS IN ONLY ONE AREA: • Prepaid and Gift users show double the number of transactions as Prepaid Only users at BILL PAY walk-up bill paying services. $ Estimated Annual Usage of Alternative Financial Services (Average number of times past 30 days annualized) Prepaid Only Prepaid and Gift Walk-up bill Walk-up bill 4.3 8.8 paying service paying service Check cashing Check cashing 4.3 3.7 service service Wire transfer service 4.6 Wire transfer service 3.8 Walk-up short-term loan/ 1.7 Walk-up short-term loan/ 2.8 payday lending service payday lending service Internet short-term loan/ Internet short-term loan/ 1.2 2.0 payday lending service payday lending serviceFIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 17
  18. 18. SPENDING CONTROL VS. SPENDING CONTROL + REWARDS BOTH PREPAID SEGMENTS PLACE A HIGH DEGREE OF IMPORTANCE ON PAYMENT METHODS THAT ALLOW FOR CONTROL OVER: • Timing of when funds are debited from their accounts • Their spending Prepaid and Gift users also express enthusiasm for payment methods, which provide loyalty points or rewards. Points or rewards tied to prepaid cards could migrate some gift card volume to prepaid cards. REW AR DS Very or Extremely Important (Top-2 box on 7-point scale) Prepaid Only Prepaid and Gift Allows control over Allows control over timing of when funds 62% timing of when funds 56% taken out of account taken out of account Helps me to not Helps me to not spend beyond my 60% spend beyond my 56% means means Provides loyalty Provides loyalty 35% 48% points/rewards points/rewards Allows me to pay for Allows me to pay for 37% 34% goods over time goods over timeFIS STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 18
  19. 19. Strategic Insights is a newsletter that provides research, thought leadership and strategic commentary on recent events inbanking and payments. The newsletter is produced by the Global Marketing and Communications team at FIS. FIS is oneof the world’s top-ranked technology providers to the banking industry. With more than 30,000 experts in 100 countries,FIS delivers the most comprehensive range of solutions for the broadest range of financial markets, all with a singular focus:helping you succeed.If you have questions or comments regarding Strategic Insights, please contact Paul McAdam, SVP, Research & ThoughtLeadership at 708.449.7743 or STRATEGIC INSIGHTS • V 8 JUNE 2012 © 2012 FIS and/or its subsidiaries. All Rights Reserved. 19