Projects and Shareholder Value in Financial Services PMI NIC, 5 Nov 09 Mauro Tortone, Chartered MCSI

Summary Publicly traded firms are expected to create shareholder value, allocating their scarce resources to the most promising operations – and projects Ten areas critical to the selection and management of projects aimed at maximising shareholder value were identified using the literature available Several weaknesses that financial firms should address to maximise SV thru projects were highlighted in an industry survey, based on the ten critical areas 2

Projects and Shareholder Value Projects – are a way in which firms take advantage of opportunities and deal with threats – are, nowadays, a continuous effort, alongside operational processes – represent, arguably, the larger portion of the future earnings of a firm Shareholder Value – Business value + marketable securities or investments – market value of debt and obligations*  Business value is the value generated by the cash flows in which all providers of funds have a claim 3 *Mills et al

The Questions How aligned are projects to maximising Shareholder Value (SV) in Financial Services? What are the areas in which improvements could be made by financial firms? Theory – in the Financial Services sector, the key to maximising SV is achieving the right mix of projects, coupled with effective allocation of resources between operations and projects Objectives: – To analyse how financial firms select and manage their project portfolios, in relation to SV – To identify the improvement areas (disconnects between projects and creating SV) – To offer recommendations on how to address the improvement areas 4

Literature Reviewed literature sources The review suggests that, though there is extensive research on company valuation and single projects appraisals, there is limited research that attempts to relate projects and SV The literature available quite clearly indicates that projects have a significant impact on SV The financial services industry is no exception Ten areas and fifty indicators: questionnaire questions 5

Questionnaire 6

Survey Well over 600 people were contacted in more than 300 of firms. Overall response rate: 9%. 59 questionnaires were returned complete (in line with expectations) Most of the respondents worked for large European financial firms which operate globally – they were from all the main organisational functions Note a small number of organisations contacted were non- financial firms (8%) from Fortune’s Most Admired Companies list, used as a benchmark for the financials Projects in Financial Services don’t appear to be selected and managed in a way that maximises SV 7

Respondents 8

Respondents (cont.) 9

10

Respondents (cont.) 11

Respondents (cont.) 12

Respondents (cont.) 13

Analysis by Area (overall scores) 14

Analysis by Area (cont.) 15

Recommendation 1 – investment appraisal (financials) The business case should either state the cost of capital assumptions specific to the project or use a risk-adjusted NPV model There should be a standard model across the organisation for NPV calculations, to ensure consistency and fair assessments of competing projects The NPV needs to be revised on a regular basis to take into account changes in the markets and confirm the business case is still viable 16

Recommendation 2 - project portfolio/ prioritisation At strategic level, mgmt should – listen to the market to understand what it considers the drivers of shareholder value creation for the firm (in the long run) – test the impact of different project portfolios with the help of models simulating the SV generated in different scenarios At operational level, mgmt should – decide, on a regular basis, which projects should be in – and out of – the portfolio, thru project portfolio reviews – form a Project Portfolio Committee, composed by functional heads and a board member, that will attend the reviews – use best practice project portfolio management tools to review and manage the portfolio 17

SVA Model 18

Project Portfolio Management 19

Project Portfolio Management (additional) Alternative perspectives: payback (period); capital already invested & achievements (v plan), capital requirements to completion (v plan) Real options: high risk-high reward initiatives that may be ruled out by low risk- adjusted NPV Cost and risk projects: respectively impact E(Ct) and αt in the Walters formula: Where: NPV(firm) = the risk-adjusted discounted present value of a firm’s after-tax earnings E(Rt) = the expected future revenues of the firm E(Ct) = expected future operating costs, including charges to earnings for restructurings, loss provisions and taxes The net expected returns in the numerator are then discounted to the present using It = risk-free rate and αt = a composite risk adjustment which captures the variance of expected net future returns resulting from – credit risk, market risk, operational risk, and reputation risk, and – the correlations between such risks associated with the firm’s various activities 20

Recommendation 3 – productivity/ performance Regular reviews of NPV assumptions, project progress Good financial and non-financial metrics DB of projects with current and historical project data: – Projects contribution, current & over time: new v old (ops) – Repeat project mistakes – avoid! 21

The Great Recession 22 Source: Interactive Data

Q&A 23 Thank you.