As deregulation and consolidation accelerate, so the banking, credit card, brokerage, and insurance industries are inexorably converging into a single personal financial services (PFS) industry. We set out to review the performance of the PFS industry as a whole and the growth and profitability of individual product categories within it for the three years 1993 to 1996. All types of household assets and liabilities were included, with the exception of pension funds. We examined the flow of funds between products and the changing sources of profitability, then tried to determine the reasons for these movements.

Our key findings run counter to conventional industry wisdom:

Balances have risen strongly, less because of new products, new markets, and cost reductions than because of asset appreciation.

The PFS industry is enormous by any standards. More than 90 percent of US households own a banking product, and 60 percent own insurance. Few products or services are as ubiquitous: brokerage leader Merrill Lynch alone services twice as many households as Kraft. With 1996 revenues exceeding $690 billion (compared with $605 billion in 1993), PFS accounts for almost 10 percent of the United States’ gross domestic product.

The industry’s asset and liability balances are dominated by directly held securities ($6.5 trillion of the $9.5 trillion investment balances), first mortgages ($3.2 trillion of the $3.6 trillion mortgage balances), and deposit products ($3 trillion) (Exhibit 1). Balances for the sector as a whole rose by 9 percent over the period studied. One of the main causes was asset appreciation, which accounted for 64 percent of the increase (Exhibit 2).

Consumer debt was another. Over the three years, the average US household saw its net worth rise from about $240,000 to $285,000. Encouraged by this growth and by PFS companies’ willingness to lend, overall consumer debt rose from $3.9 trillion to $5 trillion, and from 15 to 17 percent of income.

Overall pre-tax profits grew by 6 percent a year, slower than the industry’s balance growth. Declining profitability in two important categories, mortgages and credit cards, was responsible for the slacker pace. Even so, at $119 billion, the sector’s profits are double those recorded by the communications industry and three times those of the electronics industry. In addition, PFS companies achieved returns to shareholders approaching 28 percent over the three years, well above the S&P 500.

Household assets have shifted out of traditional products at an alarming pace, but the balances remaining in many of these categories are still enormous.

Money market fund balances grew by 16 percent a year between 1993 and 1996; checking account balances fell by 8.5 percent a year, equivalent to $134 billion over the three years. Yet 22 percent of household assets are still held in savings and checking accounts.

Similarly, consumers directed the largest share of their net new investment dollars into bond and equity funds, largely at the expense of directly held investments (stocks and bonds purchased through a broker). But although US households liquidated $320 billion in directly held securities, these still account for 75 percent of total investments (Exhibit 3). Mutual funds account for only 17 percent of household assets and 25 percent of investment assets.

Consumers assumed more equity risk over the three years, although this shift took place mainly passively as equity investments appreciated. In fact, new investments (investments less liquidations) made directly (not through pension funds) by households during this period were primarily in fixed income products (bonds, bond funds, long-term certificates of deposit, and fixed annuities) and liquidity products (checking accounts, savings, and CDs) (Exhibit 4). Variable annuities and variable universal life products (insurance policies offering equity returns) grew by 15 and 29 percent respectively, while standard ordinary life products shrank by 7 percent and fixed annuities grew by less than 1 percent.

Conventional banking products are less popular these days, but still account for the bulk of the industry’s profits.

Consumers shifted assets from conventional banking products into funds over the period we studied. Surprisingly, however, some of these slow-growing, staid products—which include traditional deposit products, trust products, and ordinary life insurance—have proved highly resilient. Benefiting from favorable market conditions, they produced most of the industry’s profits. In 1996, checking accounts, savings accounts, CDs, and MMDAs (money market deposit accounts) accounted for a whopping 44 percent of total industry profits. Though balances in these products increased by only 2 percent a year, and costs rose by 2 percent a year, profits still grew by 9 percent a year.

Trust products likewise exhibited little real growth but high profitability. Although their share of the overall US household balance sheet has remained largely unchanged at 5 percent, they recorded negative account growth, and investors liquidated $19 billion of them on a net sales basis. Yet their profitability grew by almost $800 million or 8 percent a year because of asset appreciation.

Again, ordinary life products showed little growth compared with other PFS products. Yet profits grew by 14 percent a year, helped, as with savings and checking products, by attractive interest rates. Moreover, life industry profits are able to carry on rising, albeit temporarily, when new sales are declining, because sales commission expenses also drop.

Newer products have enjoyed the strongest balance growth, but profits have dwindled.

Products that attract the greatest number of new balances may receive lots of attention in the industry, but do not necessarily exhibit the strongest growth, perhaps for that very reason. In some hot categories, intense competition during the period studied meant margins actually shrank.

Credit card companies, for example, saw their balances grow at more than twice the speed of those for credit products overall because they introduced new product benefits and developed capabilities in credit scoring and pricing that enabled them to extend credit profitably to higher-risk borrowers. Yet much of the value thus created ended up with consumers. Growth attracted new entrants and boosted competition, leading to declining spreads, lower annual fees, rising customer acquisition costs, and more delinquencies. The result: although credit card balances grew by 20 percent, profits fell by 15 percent. As competition intensifies in the subprime credit card market of higher-risk borrowers, the losses are likely to mount. These developments are leading to rapid market consolidation.

Similarly, the percentage of US households holding mutual funds rose from 33 to 46 percent over the three years, while mutual fund assets increased by 17 percent. Again, this tremendous growth attracted new competitors: almost 2,500 new funds have been launched since the end of 1992. In money market funds, the level of competition kept prices and margins flat. With equity and bond funds, although prices rose, margins narrowed slightly because distribution and marketing expenses increased.

The conclusion to be drawn from these findings is not that outmoded, dwindling products are where the industry’s future lies, but that companies must understand how to make the most of them. This is especially true for large diversified companies, and would be even more so if the economic environment were to deteriorate. With so much of the sector’s outstanding performance based on asset appreciation, interest rate spreads, and consumer confidence, a market decline, drop in spreads, or credit crunch could prick the balloon of profitability.

Our estimates indicate that if the market were to drop by, say, 20 percent, profits from investment products would plummet by 30 percent and overall industry profits by 10 percent. If interest rate spreads on deposit products were to fall to 1993 levels, industry profits would shrink by 15 percent. In a credit crunch, profits from all liability products would drop by 30 percent and overall industry profits by 8 percent. It goes without saying that more than one of these external shocks could occur simultaneously.

In such conditions, how would PFS companies continue to expand sales and profits? The best already manage their portfolios to maximize legacy profits from traditional products, and nurture promising growth businesses. The cash thrown off by dwindling products not only funds innovation and growth, but supports earnings and hence stock price, enabling companies to control their own destinies as the industry consolidates.