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Slides that describe the content of the publication: Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation", Journal of Marketing, Vol. 75 (May), 118-131
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Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation
Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer Equity Sustainability Ratio: A New Metric for Assessing
a Firm’s Future Orientation", Journal of Marketing, Vol. 75 (May), 118-131
Paper in Journal of Marketing
2
Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation", Journal of Marketing, Vol. 75 (May), 118-131.
© 2011, American Marketing Association
Aim and Contribution of Our Research
3
Customer equity should play a more prominent role in financial reporting
The aim and contribution of our research are to …
Outline the problems associated with a shift from long-term value creation to short-term profit realization
Emphasize the importance of reporting forward-looking metrics
Propose customer equity reporting (CER) and the customer equity sustainability ratio (CESR) as potential means to increase transparency in financial statements
Provide stakeholders with valuable information about the long-term value of a customer base
Argue that more forward-looking metrics might have diminished the devastating consequences of the current financial crisis
Securitization in Non-Financial Businesses (1/2)
4
Soccer club realizes earnings from ticket sales
soccer entertainment
earnings from ticket sales
$100,000,000
soccer clubsoccer club fans
5 years considered; 20 games per year; 50,000 spectators per game; $20 per ticket Total earnings of the soccer club from ticket sales: $100,000,000 ($20,000,000 each year)
Securitization in Non-Financial Businesses (2/2)
5
Soccer club transfers its future ticket sales to a bank
soccer entertainment
earnings from ticket sales over next five
years$100,000,000
soccer club
soccer club fans bank
$75,815,735
one-time earnings from securitization
Discount rate: 10% Discounted net present value of total earnings: $75,815,735
European Union’s Trouble with Greece
6
Story, Landon, and Schwartz (2010), "Wall Street Helped to Mask Debt Fueling Europe’s Crisis", Wallstreet Journal, February 14
In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example, traded away the rights to airport fees and lottery proceeds in years to come.
Banks went to Athens to pitch complex products to defer debt.
Securitization in Financial and Non-Financial Industries
7
Securitization in the financial industry:Underlying products
Securitization in non-financial industries:Underlying products
Mortgages Future telecommunications usage
Car financing Future electricity consumption
Consumer loans Future tax assets
Student loans Future health care receivables
Credit cards Future royalties of intellectual properties
Leasing claims Ticket securitization- Airlines- Railway- Sport events- Cultural events- Museums- Fairs and Exhibitions- etc.
Commercial loans
Commercial papers
Leasing claims
Insurance premiums
(e.g., Bermes 2011; Bessler 2007; Jobst 2002)
Basic Idea of Securitization in Banking (1/2)
8
t0: loans
t1 to tn: interestand amortization
loan borrowers bankloan granter
Traditional banking business is to borrow and lend money (buy and hold)
Non-securitization
Loans (mortgages, business financing, consumer loans etc.) are offered mainly to bank’s own customers
Amortization can be paid e.g. annually or at the end of the contract period (bullet loan) depending on the loan structure
Interest is paid by borrowers constantly (often monthly or annually) on loan volume outstanding
Banks earn money from the margin between the interest rate of the loan and the refinancing costs minus provisions for expected loan losses
Banks receive the interest margin constantly over the lifetime of the loan contract (for bullet loans)
Basic Idea of Securitization in Banking (2/2)
9
Traditional banking business is extended to securitization (originate and distribute)
loan borrowers t1 to tn: interestand amortization
trustee
t0: loans
t0: loan claims SPV
t0: price forloan claims
t0: loan claims
t1 to tn: interestand amortization
t0: price forsecurities
t0: securities
investors
bankloan granter
Securitization
Loans are sold to special purpose vehicles (SPV) and therewith handled outside the bank’s balance sheet
Loans are packed and structured into investment tranches with different underlying risk levels
Tranches are distributed to investors
A trustee collects interest and amortization cash flows from borrowers and redirects them to investors
Investors face the risk of loan defaults
Underestimated Risk in Securitized Assets
10
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
Securitization
Securitization
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
“First round“ collateralized debt obligations (CDO)
“Second round” collateralized debt obligations (CDO2)
Previous Research on Securitization in Finance
11
Credit and market risk Liquidity risk and funding
Through securitization, ...
Banks can manage credit and market risks of the underlying loan portfolios
E.g.:
Ambrose, Lacour-Little, and Sanders (2005)
Coval, Jurek, and Stafford (2009) Franke and Krahnen (2008) Lockwood, Rutherford, and Herrera
(1996) Luo, Tang, and Wang (2008) Purnanandam (2009)
Through securitization, ...
Banks can reach stronger liquidity positions
Banks can easier fulfill regulatory requirements such as Basel II/III
E.g.:
Ambrose, Lacour-Little, and Sanders (2005)
Calem and LaCour-Little (2004) Jones (2000) Purnanandam (2009) Twinn (1994)
Banking Example: Assumptions and Calculation Basis
12
We distinguish between a non-securitizing and a securitizing bank
The banks each issue a five-year loan volume of $100,000 to customers at the beginning of each year
The annual net interest margin of the loans is 1% (5% interest rate; 3.5% refinancing expenses; 0.5% loan loss provisions)
No other deductions or costs occur
Discount rate is 10%
The non-securitizing bank gets the interest income at the end of each year
The securitizing bank sells the whole loan volume and the related annual interest income to new investors and receives the non-interest income at the end of each year
Customer equity is valued as of the end of each year
Equity is $30,000
We analyze two cases:
Distribution case: The banks pay out all of their earnings as dividends at the end of each year
Reinvestment case: The banks reinvest the earnings at a return rate of 10%
13
Banking Example: Non-Securitizing Bank
14
Banking Example: Securitizing Bank
15
Banking Example: Effects of Securitization on Earnings (Distribution Case)
$0
$1.000
$2.000
$3.000
$4.000
$5.000
$6.000
$7.000
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Tota
l Ear
ning
s (in
k U
SD)
Year
Securitizing Bank Non-Securitizing Bank
16
Banking Example: Effects of Securitization on Return on Equity (Distribution Case)
0%
5%
10%
15%
20%
25%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Retu
rn o
n Eq
uity
(Ro
E)
Year
Securitizing Bank Non-Securitizing Bank
17
Customer Metrics to Increase Transparency in Financial Reports
CER and CESR provide comprehensive transparency information
CER provides stakeholders with valuable information about the long-term value of a bank’s current customer base (Wiesel, Skiera, and Villanueva 2008)
CER publishes detailed customer structures with related earnings and costs in absolute numbers
CER can issue a forward-looking statement
Customer Equity Reporting
(CER)
Newly developedCustomer Equity
Sustainability Ratio(CESR)
CESR compares the likely future earnings of the existing customers to current earnings
CESR identifies shifts in value realizations over time
CESR reports the sustainability of the bank’s earnings as a relative number in a simple and substantial way
Customer Equity Sustainability Ratio (CESR)
18
CESR is a new metric to quantify the intensity of long-term value creation
Defining CESRj as the metric of the PV of all future earnings to the corresponding customer lifetime value (CLV) of a customer and rearranging it leads to:
(1)j
j
j
jj
T
tt
tj
T
tt
tj
j CLV
Earn
CLV
EarnCLV
i
Earni
Earn
CESRj
j
0,0,
0
,
1
,
1
)1(
)1(
(2)
J
jj
J
jj
J
jj
J
jj
J
jj
J
j
T
tttj
J
j
T
tttj
CLV
Earn
CLV
EarnCLV
i
Earn
i
Earn
CESRj
j
1
10,
1
10,
1
1 0
,
1 1
,
1
)1(
)1(
(3)CE
EarnCESR 01
CESR for all current customers is:
Relationship Between Customer Equity (CE) and Customer Equity Sustainability Ratio (CESR)
19
Short-TermProfit Realization
with a StrongCustomer Base
Long-TermValue Creationwith a Strong
Customer Base
Short-TermProfit Realization
with a WeakCustomer Base
Long-TermValue Creationwith a Weak
Customer Base
CE (high)
CE (low)
CESR (low) CESR (high)
20
Banking Example Revisited: Effects of Securitization on CE (Distribution Case)
$0
$1.000
$2.000
$3.000
$4.000
$5.000
$6.000
$7.000
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Tota
l Ear
ning
s (in
k U
SD)
Year
Securitizing Bank Non-Securitizing Bank
$0
$1.000
$2.000
$3.000
$4.000
$5.000
$6.000
$7.000
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Cust
omer
Equ
ity
(CE)
(in
k U
SD)
Year
Securitizing Bank Non-Securitizing Bank
21
Banking Example Revisited: Effects of Securitization on CESR (Distribution Case)
$0
$1.000
$2.000
$3.000
$4.000
$5.000
$6.000
$7.000
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Tota
l Ear
ning
s (in
k U
SD)
Year
Securitizing Bank Non-Securitizing Bank
0,000
0,100
0,200
0,300
0,400
0,500
0,600
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Cust
omer
Equ
ity
Sust
aina
bilit
y Ra
tio
(CES
R)
Year
Securitizing Bank Non-Securitizing Bank
22
Empirical Study About Transparency of Securitization in Banks’ Financial Reports (1/2)
23
Empirical Study About Transparency of Securitization in Banks’ Financial Reports (2/2)
Empirical Study of Countrywide:General Information
24
Countrywide Financial Corporation (CFC) was the U.S. market leader in mortgage lending and origination between 2004 and 2007
Countrywide provides a detailed view of the shift from long-term value creation to short-term profit realization
Countrywide was heavily engaged in subprime mortgage-backed securities (MBS) transactions
Countrywide needed a rescue from Bank of America in February 2008
As a subsidiary of Bank of America, Countrywide no longer publishes its own financial statements, so our analysis comprises 1998-2007
Countrywide was the market leader in mortgage banking
Empirical Study of Countrywide:Securitization of Mortgage Loans
25
10%14%18%11%14%
28%35%
41%
90%
468,172
86%
2005
499,301
82%96%
4%
2001
123,969
95%
5%
20062000
68,923
72%
1999 2007
415,63466,740
65%
1998
92,881
59%
2004
363,364
89%
2003
434,864
86%
2002
251,901
% of Volume of Mortgage Loans Sold
% of Volume of Mortgage Loans Hold
Total Mortgage Loans Volume (in m USD)
Empirical Study of Countrywide:Earnings Structure
26
27
Empirical Counterfactual Analysis of Countrywide: Total Earnings
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008e 2009e 2010e
Tota
l Ear
ning
s (in
m U
SD)
Year
Countrywide - Securitization Case Countrywide - Non-Securitization Case
28
Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings
-3,000
-2,000
-1,000
0
1,000
2,000
3,000
4,000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008e 2009e 2010e
Diff
eren
ce in
Tot
al E
arni
ngs (
in m
USD
)
Year
Countrywide - Difference in Total Earnings (Non-Sec. Case - Sec. Case)
29
Empirical Counterfactual Analysis of Countrywide: Customer Equity
0
5,000
10,000
15,000
20,000
25,000
30,000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Cust
omer
Equ
ity
(CE)
(in
m U
SD)
Year
Countrywide - Securitization Case Countrywide - Non-Securitization Case
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Cust
omer
Equ
ity
Sust
aina
bilit
y Ra
tio (C
ESR)
Year
Countrywide - Securitization Case Countrywide - Non-Securitization Case
30
Empirical Counterfactual Analysis of Countrywide: CESR
0.673
0.210
Factor 3.2
31
Empirical Counterfactual Analysis of Countrywide: Factors in CESR
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Fact
or in
CES
R
Year
Countrywide - Factor in CESR (Non-Sec. Case / Sec. Case)
32
Securitization in Industries Outside Banking (1/2)
33
Securitization in Industries Outside Banking (2/2)
Discussion and Conclusion
34
CER and CESR provide valuable information for the firm’s stakeholders
Customer equity reporting (CER) and the customer equity sustainability ratio (CESR) are feasible in a real-world setting
CER and CESR as forward-looking customer metrics provide stakeholders with transparency about the long-term value of a firm’s current customer base
CESR can better identify shifts in value realizations over time
CESR reports the sustainability of the firm’s earnings in a simple and substantial way
CER and CESR provide insights into how investors and firms can be supported to avoid some of the challenges of a future financial crisis
Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation
35
Need more Information? Contact one of us!
Contact:Prof. Dr. Bernd Skiera Manuel Bermes Lutz HornGoethe University Frankfurt Goethe University Frankfurt Goethe University FrankfurtHouse of Finance House of Finance House of FinanceE-Finance Lab E-Finance Lab Retail Banking Competence CenterGrueneburgplatz 1 Grueneburgplatz 1 Grueneburgplatz 160323 Frankfurt am Main 60323 Frankfurt am Main 60323 Frankfurt am MainE-Mail: [email protected] E-Mail: [email protected] E-Mail: [email protected]
