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 / Winter 2011 / Issue 65(originally published by Booz & Company)


The Right Side of Financial Services

Capital One’s tale of near demise and subsequent revival illustrates the value of this approach. Through the 1990s, Capital One aggressively grew its base of credit card assets on the back of superior credit and segmentation skills. The company demonstrated an industry-leading ability to plumb databases of potential clients and offer segmented demographic groups a range of credit cards with various rates and rewards. By the early 2000s, Capital One had leveraged these capabilities across new asset classes such as auto loans. To fund these accounts, Capital One’s strategy was simple: Rely primarily on bond issuances to match asset growth.

But in 2003, Capital One’s strategy came under attack as concerns suddenly surfaced about the credit quality of some of its assets. Almost overnight, the company faced resistance in capital markets to rolling over its debt. Its share price fell abruptly by nearly 50 percent, as many investors feared that the company could not survive much longer as a stand-alone entity.

This near-death experience, several years ahead of the credit and funding crisis of 2008, became a blessing in disguise. It forced Capital One’s senior management to rethink the right side of their balance sheet to regain the confidence of Wall Street and the bond markets. After this reappraisal, Capital One acquired two retail banks: Hibernia and North Fork (in 2005 and 2006, respectively), two retail operators with large portfolios of plain-vanilla savings and checking accounts. These sticky, low-cost, and stable funding pools were precisely what Capital One needed to alter its balance sheet mix and provide long-term funding for its asset base.

Just a few years ago, few would have thought that Capital One could withstand a credit crunch of any magnitude. Yet not only did the company hold its own throughout the industry collapse, but its share price outperformed those of most financial stocks. In fact, this retail bank acquisition strategy has worked so well for Capital One that the company continues to embrace it today, recently anteing up US$9 billion to purchase the online bank ING Direct. Capital One’s experience shows how portfolio strategies can strike the appropriate balance between “client asset rich” and “client liability rich” businesses. Relying solely on wholesale markets and brokered deposits for funding is no longer a solution for many consumer or commercial banks. Instead, access to low-cost, stable funding, such as consumer or commercial deposits or even pools of insurance, is essential to long-term viability.

Of course, Capital One is now operating with retail banking businesses that are quite different from its core card business. It must thus develop the right set of business capabilities to be successful at these new businesses, lest its financial performance be weighed down by poorly run retail banks with poorly differentiated business models.

Becoming Client-Centric

Pursuing client-centric strategies at the business unit level can go a long way toward stabilizing the right side of diversified financial institutions. A client-centric strategy involves a transition from emphasizing individual products for all types of customers to serving a broad range of financial needs for a particular group of clients. These clients often require loans and have liquidities to park with their financial partner, for instance in the form of deposits; they could represent a desirable blend of left- and right-side contributions to the balance sheet.

Silicon Valley Bank, a midsized commercial banking firm, provides a good example of this strategy. Most of the bank’s asset growth in the last five to 10 years has come from venture capital clients. Working with these entrepreneurs, the bank discovered that the venture capitalists were often at two distinctly different points in their funding cycles: Some had credit needs (for instance, before they could issue capital calls to their investors); others were flush with liquidity (for instance, after they had received investor funds and as they gradually put these funds to work).

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