With the increasing availability of transaction-based capital markets products, banks' core middle-market customer relationships will likely be only one-half to one-third as profitable as they are today.
As outlined in the first part of this series, banks can choose one of three options: to opt out of the capital markets; to emphasize product specialization; or to actively enter the competitive capital markets arena.
Banks choosing to offer a universal product set must aggressively position themselves in this broader framework and develop a relationship management model that will succeed in the new paradigm.
Based on in-depth study of the banking and financial services industry, as well as numerous client engagements, Booz-Allen has identified three broad-based strategic options for banks seeking to enter the capital markets.
The lowest risk of these options is to obtain access to the capital markets through an alliance or partnership-what we have termed the call option.
The second, slightly more aggressive option is to build the infrastructure needed to cross-sell capital markets products into the existing client base.
The most dynamic and aggressive option is to build a full-service capital markets capability, actively investing in cross-selling and creating a revenue-generating business that could stand on its own.
The option pursued depends on a bank's current business position and competitive strength. The call option is suitable for banks whose existing relationships are not unduly threatened from capital markets product substitution, but who want to reserve the right to participate in this arena in the future.
These institutions must determine that outsourcing or partnering will not compromise control of their client relationships.
PNC Bank Corp. has pursued this model with Friedman, Billings, Ramsey & Co., while First Chicago NBD Corp. provides clients additional services through Robert W. Baird & Co.
The second option, cross-selling, is appropriate for banks who perceive that their core client franchise is at risk from product substitution, unbundled buying, and/or predatory pricing. Building an infrastructure to support this strategy is a significant investment and, accordingly, the future opportunity to expand relationships and improve profitability must be substantial.
Recent examples of this model include U.S. Bancorp's acquisition of Piper Jaffray, the SunTrust-Equitable combination, and First Union Corp.'s purchase of Wheat First Butcher Singer.
To justify the most aggressive option-building the capital markets business-banks must demonstrate that this expanded franchise represents a valuable addition to the existing business and product portfolio and will extend beyond the traditional credit customer base. The Bankers Trust-Alex. Brown and NationsBank-Montgomery Securities organizations have pursued this model with relative success, as has Chase Manhattan Corp. and J.P. Morgan & Co.
Whichever option is adopted, we expect that banks will find that it takes a tremendous amount of follow-up work to make these deals pay. Most, if not all, of the commercial bank-investment bank hookups have been hastily consummated to get the deals done before all the "hot tickets" are gone.
Even the best thought out of these combinations will have to confront substantial challenges in bridging the divide between investment banking and commercial banking. The most formidable include:
How to agree on mutually attractive target industries and customers.
How to reconcile investment banking requirements for specialization and critical mass with the diversified customer portfolios of commercial banks.
How to share customer coverage and relationship management responsibilities between generalist commercial bankers and corporate finance "specialists."
Banks will have to tackle these challenges in two stages. The first is to do a much more systematic job of understanding customer opportunities and threats. The key questions that have to be answered are:
Which of your customers and industry groups are most likely to increase their use of investment banking products in four key areas-equity, M&A, high-yield, and securitization?
Where do you have strong relationships that you can leverage to win corporate finance mandates-i.e. you are the sole or lead bank, your relationship is with the CFO or CEO?
How deep is your investment banking capability by key customer or industry group-not just the corporate finance professionals, but sales and trading, market making and research?
Answering these questions will permit banks to begin aligning resources against the most significant opportunities. Next, banks will have to grapple with the second big challenge: redefining the customer coverage and relationship management model.
In this competitive and fast-changing area, the traditional relationship management model-cross-selling one or two products like cash management on the back of the credit relationship-is already under tremendous strain. The broader range of product offerings require an upgrade of relationship manager skill sets. In addition, ongoing segmentation of the customer base makes one-size-fits-all service levels obsolete.
Further, increased sophistication of products and the need to actively cross-sell requires greater coordination between relationship managers and product specialists.
Therefore, we expect new relationship management models to emerge as commercial banks plunge into the investment banking business.
They will resemble neither the old commercial banking model nor the investment banking relationship models. Instead, they will have to break new ground to enable banks to deal with the differences between investment banker and commercial banker compensation and culture, as well as to sell corporate finance "transactions" that paradoxically require enormous levels of customer knowledge and trust.
The complexity of reinventing these building blocks to fit and add value to a bank's new capital markets-focused strategy can be daunting, and the changes these activities bring are often profound.
But putting all the pieces together-organizational structure, processes, people skills, incentives, and leadership resolve-can enable a bank to become a full-service universal bank competitor well prepared to tackle the competitive challenges that lie ahead.