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The Game Changers

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The Game Changers The game changers Challenger Banking Results May 2015 kpmg.co.uk The Challenger Landscape THE FUTURE FIGHTERS THE NIFTY NEWCOMERS THE SMART SHOPPERS LARGER CHALLENGERS SMALLER CHALLENGERS LARGE RETAILERS The Larger Challengers are typically The Smaller Challengers have typically The increasingly large existing retailers longer established. Two of them are been incoprorated in the past five have entered the financial services relatively new in terms of branding but years and were private equity backed market offering unsecured products and have inherited relatively large portfolios through their initial growth phase. savings accounts. The longer established of loans and advances to customers. Four of them are now listed banks. Challengers, such as Tesco and M&S, are expanding their offering with products such as current accounts and mortgages thus further challenging the big banks. ALDERMORE STB SHAWBROOK WILLIAMS & GLYN** NATIONWIDE** M&S ASDA MONEY FIRST DIRECT** POST OFFICE* NAB VIRGIN TSB HANDELSBANKEN METRO ONESAVINGS TESCO SAINSBURY’S CHALLENGER ST CHALLENGER ST HSBC BARCLAYS LLOYDS RBS SANTANDER THE BIG FIVE BIG FIVE ST BIG FIVE ST The high street is dominated by a small group of retail banks along with mutuals, where Nationwide is the dominant player. Throughout the report the ‘Big Five’ banks referred to are HSBC, Barclays Bank, Lloyds Bank, The Royal Bank of Scotland and the UK subsidiary of Santander. DIFFERENTIATORS BRAND PRODUCTS CULTURE & CUSTOMER SERVICE DISTRIBUTION Major banks have suffered reputational Some Challengers offer different or niche Some Challengers are presenting themselves as New retailers are focusing on a less traditional damage since the financial crisis. Some products that are not necessarily offered more customer focussed and embedding a fair and distribution model, relying more on brokers and Challengers are differentiating themselves by the big banks to gain custom. ethical culture in their approach to banking. online platforms. Large, non-banking retailers such by focusing on their brand and reputation. as supermarkets are utilising their already existing outlet network to distribute and facilitate day-to-day * Post Office financial services are provided by Bank of Ireland UK ** Nationwide, Williams & Glyn and First Direct data not included in analysis transactions. 1 © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 2 A game changing year The last year has been an important one for the Challenger Is differentiation alone enough? sector. Five banks have listed on the London Stock In theory, differentiation can be driven by resources (the Exchange, raising over £350m of new capital to fund things a bank has available to it) or capabilities (how those growth and strengthen balance sheets. Over the same things are deployed). period, lending assets for these banks increased by 16% compared to a decline of 2.1% for the Big Five. In banking, resources are driven by the brand, distribution and product set. Capabilities are driven, above all, by culture For many of the Challengers, this growth has also and how this manifests itself through customer service. resulted in improvements in profitability. In the group categorised as Smaller Challengers, return on equity In this report we examine how the Challengers measure (RoE) reached a staggering 18.2% in 2014, which up on each of these four attributes and question if these contrasts starkly with a market where single digit – or sufficiently differentiate them within the market. Our even negative – RoEs are the norm. However, this isn’t findings suggest that while the foundations are there, the case for all Challengers. For the group categorised for most, the journey ahead will require continued rapid as Larger Challengers, RoEs were more closely aligned change. Digital banking is a great example – we found with the market. The picture is therefore much more that the mobile functionality of the Challengers is at best complex than many commentators allude to. With many equal to, but often worse than, the Big Five. For those different business models between them, analysis Challengers focussing on customer service or cost as a of the Challenger bank market is a tricky task. differentiator this could be a major hurdle for the future. Some Challengers have a cost advantage Theories of competitive advantage help to show that banks need to either develop a cost advantage or differentiate in order to compete effectively. Established thinking would have us believe that cost Cost advantage is driven by scale. In banking this is true in part, however, with scale also comes complexity. The scale benefits that should be gained by the Big Five have been partly eroded by unwieldy legacy IT systems, regulatory change, costly real estate and compliance issues. So in Brand Distribution 2014, despite being significantly smaller, the Challengers or reported only slightly higher costs, with an average cost to income (CTI) ratio of 64% (excluding National Australia Bank) compared to 63% for the Big Five. However, this crude measure oversimplifies a complex picture. The Smaller Challengers produced a CTI ratio of just Differentiate? 53% in 2014, significantly better than the market, while the Larger Challengers track much more closely to the market. This can be down to a range of factors, including a number of one-off costs offset by a simpler business model and product set. Products Culture & customer service 3 © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Highlights The Challengers are outperforming Despite being significantly smaller, the Big Five in terms of growth Challengers have on average (compound annual growth rate 8.2% similar cost to income ratios between 2012 and 2014 compared to a to the Big Five reduction of 2.9% for the Big Five) Challengers have on average a Smaller Challengers beat greater return on equity their Larger counterparts than the Big Five banks on RoE and growth RESULTS INSIGHTS In order to compete, the Larger Large Retailer Challengers Challengers need to further need to capitalise on their differentiate themselves from brand power the competition The Big Five have lessons to The future of Challengers learn from the Challengers on is technology more effective culture © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International 4 Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Financial Analysis 5 © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Returns across the sector continue to grow Between 2012 and 2014 the average return on equity Return on equity across the Challenger banking sector continued to grow – from a negative RoE of 4.0% in 2012 to a positive return 18.2% of 3.8% in 2014. This compares to average RoEs of 0.7% and 2.8% in 2012 and 2014 respectively for the Big Five. SMALLER CHALLENGERS** Of course, RoEs based on reported profits are a crude measure at best, given the complexities of accounting 5.0% and the scale and frequency of so called ‘non-recurring’ items. However, directionally the picture is clear. A wide range of factors have contributed to this 2012 2014 improvement, including scale benefits, clever targeting of niche markets and benign market conditions. LARGER The performance of the group as a whole is only CHALLENGERS marginally better than the Big Five with their entire legacy IT and conduct costs. So, on this measure it would be easy to conclude that there is much more the Challengers should and could do to improve performance. 2.1% (4.5%) Larger Challengers vs. Smaller Challengers – a very different picture Taking the analysis to a further level of detail shows 2012 2014 that the RoE for the Smaller Challengers significantly outperform the Larger Challengers. The 2014 average RoE for the Smaller Challengers of 18.2% is better than Google (under 15% at March 2015)1 or Facebook THE BIG FIVE (under 11% at March 2015)2. This is a phenomenally good result, which demonstrates that despite record low interest rates and intensifying market competition, there are pockets of profitability in UK banking. 2.8% What almost all of the Smaller Challengers have 0.7% in common is that they are niche players. As Andy Golding, CEO of OneSavings Bank put it, they are 2012 2014 “dancing in the gaps” left behind by the major banks3. On the flip side, the Larger Challengers achieved an average RoE of only 2.1% in 2014 with a relatively wide range of results – from minus 7.2% to plus 10.4% – reflecting (at the lower end) conduct related charges and accounting adjustments. Sources: 1. https://ycharts.com/companies/GOOG/return_on_equity. 2. https://ycharts.com/companies/FB/return_on_equity. 3. www.ft.com/cms/s/0/ d777f408-aac9-11e3-83a2-00144feab7de.html Note: *Return on equity is a weighted average and is calculated as profit after tax attributable to shareholders divided by average shareholder’s funds. **Metro Bank is not included as its 2014 annual accounts are not yet available. © 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International 6 Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Challengers are on the up The Challenger banks have grown their loan books Growth in loans and advances to customers year-on-year, achieving a compound annual growth rate (CAGR) of 8.2% between 2012 and 2014.
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