Amidst Dramatically Altered Financial Landscape, Conventional Business Models Will No Longer Produce Sufficient Profits to Cover Increased Cost of Capital

“This Too Shall Pass” No Longer a Credible View

NEW YORK--(BUSINESS WIRE)-- Facing escalating challenges in a fundamentally altered financial landscape, U.S. regional banks must reduce costs by as much as 40% to ensure long-term survival, according to a new analysis by Alvarez & Marsal, a leading global professional services firm.

“As banks continue to face mounting macro economic headwinds, it has become clear that most conventional banking business models will no longer produce sufficient profits to cover their now increased cost of capital,” said Joe Berardino, A&M managing director and member of its banking sector team. “Current business models are unfocused, undifferentiated and high cost and there is simply too much capacity chasing too little demand.”

He pointed to analysts’ reports that indicate only three of the top 25 regional banks are expected to be profitable by 2013.

“The view that ‘this too shall pass’ is no longer credible given the long term hurdles facing the sector,” added Paul Cantwell, managing director and member of the firm’s banking team. “Companies, governments and households are unwinding leverage, which is restricting growth. Instability in Europe is structural – not cyclical – and is contagious. And tighter regulations, such as the living will provisions of Dodd-Frank, are increasing costs.”

The analysis also found that:

• The cost of equity has increased by 50% from pre-financial crisis levels, while the typical return on equity has fallen by half. In a protracted, low growth environment, market to book ratios will be low.
• Most banks lack a sufficient holistic understanding of what elements of their business model contribute net profit or loss.
• Traditional paths to increased profitability (revenue growth, reduced loan losses, additional risk/increased leverage, yield curve profits), are not feasible in the near term.
• For every 1% gap between actual and target ROE, banks will need to take out 5-6% of their cost base.
• The gap will be too big to close for many banks, prompting industry consolidation to remove excess supply.
• A small number of banks are going to stand out from the pack in aggressively building a product, services and delivery model that can make money in a protracted low growth, oversupplied market; the rest will be acquisition targets.

“Some banks have already seen the proverbial writing on the wall and taken steps to eliminate waste and inefficiency,” said Seamus McMahon, a senior advisor to A&M’s banking practice. “However, those efforts, most of which have involved headcount reduction, have only generated a fraction of the savings needed. To move beyond that, banks are going to be forced to make tough and unconventional strategic decisions. And those that can focus their business models with fundamentally lower costs are going to be in the best position to succeed. The bottom line is that there is now a real sense of urgency to take action.”

A&M is working with several financial institutions to rationalize their business models in a way that leverages core products, services and customers and, at the same time, provides a low cost platform for the future. The firm is also working with clients to respond to regulatory requirements, including the living will provisions under Dodd Frank, that will impact their business models.

About Alvarez & Marsal

Alvarez & Marsal (A&M) is a global professional services firm specializing in turnaround and interim management, performance improvement and business advisory services. A&M delivers specialist operational, consulting and industry expertise to management and investors seeking to accelerate performance, overcome challenges and maximize value across the corporate and investment lifecycles. Founded in 1983, the firm is known for its distinctive restructuring heritage, hands-on approach and relentless focus on execution and results.

The firm’s global Financial Services practice has been at the forefront of working with financial institutions in the wake of the credit crisis, advising clients on a host of operational, financial and regulatory issues including dealing with lingering pools of troubled assets, risk management, due diligence and performance improvement matters. A&M has led the global wind-down of Lehman Brothers, the largest and most complex bankruptcy in history, as well as the restructuring of Washington Mutual.

The firm’s team comprises seasoned bank executives from diverse and extensive backgrounds and former senior financial institution regulators , who bring unique and specialized expertise in credit compliance, equity and regulatory issues, balance sheet management, capital planning, as well as examining and managing risk at banks from the community level up to some of the largest institutions in the world.

For more information on A&M, visit www.alvarezandmarsal.com.

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