Valuation of the Financial Services Industry

Industry Overview

The financial services industry, SIC codes 60 - 62, covers banking institutions, related credit institutions, and securities brokers. Companies in the financial services sector work closely with both individual consumers and corporate clients to help them meet their financial

After years of eliminating public branches in favor of pursuing corporate clients, many banks are returning to their consumer service roots. Basic consumer banking products such as checking accounts and car loans are often more reliable sources of profit than corporate loans and securities. Bank of America, J.P. Morgan Chase, and Bank One Corp. have all announced plans to open a significant number of new consumer branches over the next few years.

The increase in consumer-oriented banking is not without risk. Competition for consumers is likely to encourage consumer friendly deals, but trimming fees and offering free checking decreases the profits generated by retail banking. Selling financial services to the American public may also require some fancy footwork. The recent 2003 American Banker/Gallup Consumer Survey found public confidence in the US banking and financial systems at a seven year low. The survey also reported that customers' satisfaction with their primary financial institution has fallen to the lowest level in almost twenty years.

Banks are popular with consumers seeking long-term financial planning services. About 43 percent of the respondents in the American Banker/Gallup Consumer Survey said banks would play the largest role in achieving their long-term financial goals. Mutual Fund companies were favored by 31 percent, brokerage firms by 15 percent, and only 5 percent favored insurers. There is still competition for high net-worth customers, however. Most retail brokerages have highly trained brokers who work for incentive-based compensation. Bank and credit union employees, who typically receive salaries and small bonuses, have less incentive to pursue big dollar clients.

According to the American Banker/Gallup Consumer Survey, online services are growing in popularity, especially online bill payment. Banks have done a better job promoting online financial services than credit unions and thrifts.

Mergers and Acquisitions

The recently announced acquisition of FleetBoston Financial by Bank of America drew attention to the possibilities of consolidation in the financial services sector. Bank of America's stock value decreased as investors speculated that the bank was overpaying for FleetBoston. FleetBoston, however, saw its share price increase. A similar rise and fall accompanied the rumor that Citigroup was considering buying Washington Mutual Inc. Citigroup shares dropped 2.3 percent in value while Washington Mutual shares rose in price.

Mid-cap mergers and acquisitions activity has slowly declined in the industry. Large-cap activity has waxed and waned since 1999, with the largest increase in deal activity occurring in 2000. The year 2001 saw significantly fewer deals in the large-cap market, and the 2002 total increased only slightly from the previous year.

Industry Regulation

In response to the US Patriot Act, enacted two years ago, the Treasury Department has issued more than a dozen regulations expanding the responsibility of financial institutions to counter money laundering and terrorist financing. The Treasury has made an effort to apply its requirements equally to companies across industry sectors that compete with each other and provide many of the same services. The Treasury wants to ensure, for example, that someone wiring money from the US to a foreign country can't avoid customer identification requirements by working through a broker-dealer instead of a bank. Financial institutions that have not yet been made subject to the Act's provisions, such as nondepository lenders and insurers, should be prepared to eventually face requirements similar to those placed on institutions currently covered by the Act.

Congress is currently working to finalize legislation updating the 33-year old Fair Credit Reporting Act (FCRA). The House and the Senate have each approved different versions of the bill, and are now working to reconcile them. There are several points of difference between the two versions. The Senate bill, for example, would limit the ability of credit companies to market to each other's customers, while the House version would preempt stronger state identity theft laws and require companies to investigate when a customer disputes information supplied to credit agencies. The Bush administration has endorsed both bills and is publicly taking the middle ground.

Outlook

Since the industry is both closely tied to the economy and subject to changes in regulation, its future is difficult to predict. If the economy improves, as many analysts predict it will, demand for financial services can be expected to increase. The continued development of new product offerings and technologies such as online services should also draw customers to the industry. Financial Services providers will need to remain aware of potential regulatory changes and prepare to meet the challenges they bring.

Sources: American Banker, Deal Retriever, Done Deals, Wall Street Journal