Executive Development Program Bank Profitability … 2016/Marsico_Product_and_Custom… · Cost of Funds Total interest ... Matched Maturity - Coterminous. 26 Profitability Components

Performance Measurement

StrategicManagement

Profit & ProcessImprovement

Board & Management Advisory Services

Financial Advisory

Executive Development Program

Bank Profitability Module

Product and Customer Profitability

April 8, 2016

1

Product and Customer Profitability

2

Whole Bank Profitability Measurement

Return On Average Assets

Reflects the institution’s return on the resources

(assets) deployed.

Target - ROAA > 1.00% or 100 Basis Points

Return on Average Assets

(ROAA) =

Net Income

Average Total Assets

3


Return On Average Equity

Reflects the institution’s return on the shareholder’s

investment (equity).

Target - ROE > 15.00%

Return on Average Equity

(ROAE) =

Net Income

Average Stockholder’s Equity

4


Net Interest Margin

The difference between interest income and interest

expense expressed as a percentage of average earning

assets.

Target - NIM > 4.00% or 400 Basis Points

Now, with a low rate environment…> 3.50% is new norm

Net Interest Margin (NIM) = Net Interest Income

Average Earning Assets

5


Yield on Earning Assets

Total interest income expressed as a percentage of

average earning assets.

Target YOEA > 4.00% or 400 Basis Points

Yield on Earning Assets = Interest & Dividend Income

Average Earning Assets

6


Cost of Funds

Total interest expense expressed as a percentage of

average interest bearing liabilities & non-interest

bearing deposits.

Target Cost of Funds < 0.75% or 75 Basis Points

Cost of Funds = Interest Expense

Average interest-bearing liabilities

& non-int. bearing deposits

7


Efficiency Ratio

Depicts how much in operating expense to generate $1

of revenue. The lower the ratio, the more efficient the

organization.

Target – Efficiency Ratio 50-60%

An efficiency ratio of 55% means it cost 55 cents to earn $1.00

worth of revenue.

Efficiency Ratio = Operating Expense

Net Int. Income + Non-Interest Income

8


Net Interest Margin

Depicts operating expense as a percent of average

assets.

Target – Expense Ratio 2.50% - 3.50%

Expense ratio is driven by bank strategy. The lower the ratio, the

more efficient the bank.

Expense Ratio = Operating Expense

Average Assets

9


Uniform Bank Performance Report (UBPR) – Summary Ratios Report

Earnings & Profitability (percent of AA)- Interest Income (TE)- Interest Expense- Net Interest Income (TE)- Non Interest Income- Provision- Pretax Net Operating Income- Realized Gain/Loss Secs- Net Operating Income- Net Income

Margin Analysis- Avg. Earning Assets to Avg Assets- Avg Interest Bearing Funds to Avg

Assets- Interest Income (TE) to Avg Earning

Assets- Interest Expense to Avg Earning

Assets- Net Int Inc (TE) to Avg Earning

Assets

10

Profitability Information: Why Do You Need It?

Profit Continuum: Whole Bank

Return on: Assets or Equity

Net Interest Margin Fee Income Expense Ratio

YOEA Cost of Funds

Efficiency Ratio

11


Profit Continuum: Dupont Drill Down

Net Interest Margin (NIM)

Product Spreads

Funds Transfer Pricing (FTP)

Interest Rate RiskOrganizational Unit Spread

Customer Spreads

12


Product Profitability: Loss Leader Theory

Satisfactory

Profitability * Profitable** Unprofitable

Banks 22.22% 44.44% 33.33%

Thrifts 22.22% 44.44% 33.33%

*Satisfactory Profitability is > 1.00% pretax return on portfolio balances.

**Profitable is 0% - 1.00% pretax return on portfolio balances.

Source: The Kafafian Group 3Q15 Profitability Peer Group.

Portfolio groups include: C&I loans, commercial real estate loans, residential

real estate loans, consumer loans (including home equity), DDA checking,

NOW checking, savings, money market, CD's.

13


Branch Non-Interest Expense

Source: The Kafafian Group profitability peer database

14


Branch Indirect Expense

Source: The Kafafian Group, Inc.

15


Case Study: Commercial Loan Product

(All % are annualized)

1 Gross Funds Provided (Used) (120,761) 100.00% (102,828) 100.00% (95,866) 100.00% (98,406) 100.00% (97,166) 100.00%

2

3 P & L:

4 Interest Income 2,063 6.85% 1,541 6.08% 1,491 6.19% 1,322 5.34% 1,257 5.20%

5 Cost of Funds 1,182 3.93% 951 3.75% 825 3.42% 762 3.08% 680 2.81%

6 Total Interest Spread 881 2.93% 590 2.33% 666 2.76% 560 2.26% 577 2.39%

Q2 Q1 Q4 Q3 Q2

Note: Q1 Interest Income includes a significant reversal of interest income from a non-performing loan.


16


Case Study: Mortgage Lending Department

(All % are annualized)

1 Interest Income 5,631 7.20 % 5,908 7.31 % 6,189 7.40 % 6,353 7.60 % 5,956 7.61 %

2 Cost of Funds 4,742 6.06 % 4,930 6.10 % 5,168 6.18 % 5,243 6.27 % 5,061 6.46 %

3 Net Asset Spread 889 1.14 % 978 1.21 % 1,021 1.22 % 1,110 1.33 % 895 1.14 %

4 Credit for Funds 54 0.07 % 37 0.05 % 37 0.04 % 72 0.09 % 50 0.06 %

5 Interest Expense 23 0.03 % 14 0.02 % 29 0.03 % 27 0.03 % 7 0.01 %

6 Net Liability Spread 31 0.04 % 23 0.03 % 8 0.01 % 45 0.05 % 43 0.05 %

7 Total Interest Spread 920 1.18 % 1,001 1.24 % 1,029 1.23 % 1,155 1.38 % 938 1.20 %

8 Funds Credit Allocated Equity 204 0.26 % 211 0.26 % 222 0.27 % 227 0.27 % 213 0.27 %

9 Net Interest Spread 1,124 1.44 % 1,212 1.50 % 1,251 1.49 % 1,382 1.65 % 1,151 1.47 %

10 Provision for Credit Loss 20 0.03 % - 0.00 % 60 0.07 % 60 0.07 % 60 0.08 %

11 Marginal Inc (Loss) After Prov. 1,104 1.41 % 1,212 1.50 % 1,191 1.42 % 1,322 1.58 % 1,091 1.39 %

12 Non-Interest Income 206 0.26 % 122 0.15 % 89 0.11 % 533 0.64 % 244 0.31 %

13 Total Income 1,310 1.67 % 1,334 1.65 % 1,280 1.53 % 1,855 2.22 % 1,335 1.70 %

14 Direct Expense 201 0.26 % 226 0.28 % 581 0.69 % 840 1.00 % 848 1.08 %

15 Indirect Expense 90 0.12 % 113 0.14 % 296 0.35 % 437 0.52 % 417 0.53 %

16 Total Non-Interest Expense 291 0.37 % 339 0.42 % 877 1.05 % 1,277 1.53 % 1,265 1.62 %

17 Pretax Profit (Loss) 1,019 1.30 % 995 1.23 % 403 0.48 % 578 0.69 % 70 0.09 %

Q2 Q1 Q4 Q3 Q2


17


Case Study: Trust Department

1 Non-Interest Income 424 100.00 % 447 100.00 % 366 100.00 % 375 100.00 % 346 100.00 %

2 Total Income 424 100.00 % 447 100.00 % 366 100.00 % 375 100.00 % 346 100.00 %

3 Direct Expense 370 87.26 % 380 85.01 % 457 124.86 % 429 114.40 % 435 125.72 %

4 Indirect Expense 71 16.75 % 73 16.33 % 73 19.95 % 67 17.87 % 71 20.52 %

5 Allocated Overhead 125 29.48 % 131 29.31 % 136 37.16 % 119 31.73 % 110 31.79 %

6 Total Non-Interest Expense 566 133.49 % 584 130.65 % 666 181.97 % 615 164.00 % 616 178.03 %

7 Pretax Profit (Loss) (142) (33.49)% (137) (30.65)% (300) (81.97)% (240) (64.00)% (270) (78.03)%

Q4Q2 Q1 Q3 Q2


18


Product Profitability Decision Tree

19

Profitability Measurement

Organizational Profitability

• Management tool to assist in improving organization

performance by measuring the results of organizational units

that reflect how the institution is managed

• Assist in strategic decision making and the budget process

• Assist in the measurement of performance (i.e., units/people)

• Assist in the determining of performance rewards, i.e.

compensation, bonuses, incentives

• Provide the detail to understand and evaluate complex issues

and problems

20


Organizational Profitability – Typical Structure

Board

President/CEO

Senior Lender

Commercial

Consumer

Residential

Loan Ops/Servicing

Credit Branch Admin

Branches

Operations

IT

Deposit Ops

Facilities/Security

Marketing HR

Payroll

Training

Compliance Finance

Audit Officer

21


Product Profitability

• Marketing tool to determine organizational resources required to

deliver products to customers versus the revenue per product

• Assist in strategic decision making

• Assist in product development

• Assist in the measurement of the success of certain marketing initiatives (ROI analysis, etc.)

• Provide the detail to understand and evaluate complex issues and

problems

22


Product Profitability

Fund Providing:

• Demand Deposits

• Savings Deposits

• Time Deposits

• Other Borrowings

Fund Using:

• Investments

• Short-Term Assets

• Loans

Non-Fund/Fee-Based:

• Safe Deposit Boxes

• Mortgage Servicing

• Trust, Insurance, Brokerage, etc.

23


Customer Profitability

• Marketing tool to determine organizational resources required to

serve customers versus the revenue per customer

• Assist in strategic decision making to determine the most

profitable customers to keep and prospective customers to

pursue

• Critical input into determining service levels (i.e. platinum, gold,

silver service, etc.)

• Can roll up into relationship manager profitability to measure

individual RM performance

• Provide the detail to understand and evaluate complex issues and problems

24

Profitability Components

Funds Transfer Pricing - FTP

The “Art/Science” of crediting fund providers

(deposits, borrowings, capital) for generating

funds, while at the same time charging fund users

(loans and investments) for using funds…..at a

market rate which considers various product risks

and maturity characteristics.

25



• Single Rate/Pool (sometimes actual cost of funds)

• Specific Matching (both sides of balance sheet)

• Multiple Pools

• Matched Maturity - Coterminous

26



27


Funds Transfer Pricing – Actual Spread Versus FTP

CQ PQ Difference

Interest Income 5.95% 5.70% 0.25%

Interest Expense 1.95% 1.85% 0.10%

Net Spread 4.00% 3.85% 0.15%

Fund Using Prods. CQ PQ Difference

Interest Income 5.95% 5.70% 0.25%

FTP-Cost of Funds 3.81% 3.65% 0.16%

Net Spread 2.14% 2.05% 0.09%

Fund Providing Prods. CQ PQ Difference

FTP-Credit for Funds 3.89% 3.73% 0.16%

Interest Expense 1.95% 1.85% 0.10%

Net Spread 1.94% 1.88% 0.06%

Mismatch Spread -0.08% -0.08% 0.00%

Cost Basis

Market Basis

28


Capital Assignment – Risk Adjusted Return on Capital (RAROC)

• RAROC is considered to be a “best practice” tool for measuring

risk vs. return in the financial services industry. It provides a

framework for measuring risk-adjusted financial performance of

organizational units, products, and customers.

29


Capital Assignment – FRB Risk Categories

• Credit

• Market (Interest Rate)

• Liquidity

• Reputation

• Legal

• Operational

30


Capital Assignment – RAROC Sample

Low Medium High

Risk Rating Scale 1 2 3 4 5

Capital Assignment 0% 4% 8% 12% 16%

Assigned Capital

Risk Categories Credit Interest Rate Liquidity Composite Capital ($000)

Risk Weights 55% 35% 10% 100%

Balance

Loans: ($000)

Commercial & Industrial 100,000 4 2 2 3.10 8.40% 8,400

Commercial Real Estate 200,000 2 4 4 2.90 7.60% 15,200

Construction 40,000 5 2 2 3.65 10.60% 4,240

Consumer 50,000 3 3 3 3.00 8.00% 4,000

Residential Real Estate 100,000 2 4 4 2.90 7.60% 7,600

Total Loans 490,000 8.05% 39,440

31


Capital Assignment – RAROC Customer Example

Low Medium High

Risk Rating Scale 1 2 3 4 5

Capital Assignment 0% 4% 8% 12% 16%

Assigned Capital

Risk Categories Credit Interest Rate Liquidity Composite Capital ($000)

Risk Weights 55% 35% 10% 100%

Loans: Balance

Loan on building(CRE) 250,000 2 4 4 2.90 7.60% 19,000

Home equity loan 50,000 3 3 3 3.00 8.00% 4,000

Deposits/funding:

Business checking 30,000 1 2 2 1.45 1.80% 540

Funding gap 270,000 1 2 2 1.45 1.80% 4,860

Total Capital for Customer 28,400

Capital Ratio 9.47%

Pre-tax ROE Hurdle Rate 15.00%

Pre-tax Profit Requirement $4,260

32


Capital Assignment – What’s Your “Well Capitalized”Capital Capital

Current Well Risk Required Required

Period Capitalized Buffer (% ) $

(Dollars in Thousands)

1 Total Cash & Bals Due $28,428 5.00% 0.15% 5.15% $1,464

2 Investment Securities 339,217 5.00% 1.25% 6.25% 21,201

3 Net Loans & Leases 2,203,532 5.00% 2.35% 7.35% 161,960

4 Other Assets 82,441 5.00% 0.50% 5.50% 4,534

5 Total Assets $2,653,618 5.00% 2.13% 7.13% $189,159

6 Total Deposits $2,229,590 0.90% 0.90% $20,066

7 Fed Funds & Repos 24,104 0.20% 0.20% 48

8 Borrowings 144,424 0.25% 0.25% 361

9 Other Liabilities 13,221 0.00% 0.00% 0

10 Total Liabilities 2,411,339 20,476

11 Total Equity 242,279 Required Equity ---- > $209,635

12 Total Liabilities + Equity $2,653,618

13 Total Equity (actual) $242,279

14 Total Equity (required) 209,635

15 Buffer (deficit) 32,644

16 Your Well Capitalized 7.90%

33


Cost Assignment

Activity-based-costing

Full absorption versus standard costing

Variable/fixed-direct/indirect costs

Isolating efficiencies/inefficiencies

Capacity utilization

Allocations methodologies:

• Average balances

• Fixed percentages

• Statistical databases

• Weighted statistics

• Direct Dollar Assignment

• Rate X Volume (ABC)

34


Cost Assignment

Daily

Time Salary

Name Activities (mins) Data

Jane Doe Deposit Servicing Rep II $25,189

20% NSF (comml & retail dda) 10 96 $5,038

30% Processing outgoing returns (all checking) 10 144 $7,557

30% Verification of new checking acct (all checking) 10 144 $7,557

10% Processing outgoing mail (bank ovhd) 98 48 $2,519

5% Posting data input (customer change requests/all deposits) 1 24 $1,259

5% Phone calls, etc. (dept ovhd) 99 24 $1,259

$0

Totals: 480 $25,189

Product

Group

Number

35


Cost Assignment

Product

Group Allocated Allocated

Number Product Group Name $'s %'s

1 All deposits 13,790 10.10%

2 CDs/ Savings/ DDA/ MMDA 7,912 5.80%

3 CDs 7,912 5.80%

4 All retail deposits 989 0.72%

5 IRAs & CDs 2,024 1.48%

6 Internet Banking 4,243 3.11%

7 All retail checking 6,365 4.66%

8 All retail checking & savings 10,608 7.77%

9 All checking/ savings / MMDA 10,348 7.58%

10 All checking 33,062 24.23%

11 All savings 1,863 1.36%

12 IRAs & MSAs 15,985 11.71%

13 Misc branch fees 5,460 4.00%

14 MSAs 9,161 6.71%

15 IRAs 4,228 3.10%

0 0.00%

98 General Bank Overhead 2,519 1.87%

136,469 100.00%

99 Local Department Overhead 47,828

36


Cost Assignment – Step Variable Cost

A step-variable cost is a resource that is obtainable

only in large chunks (such as ops workers) and

whose costs change only in response to fairly wide

changes in activity.

Volume

Cost

37

ROI Exercise

Money Market Campaign

Personal

MMDA

Business

MMDA

1 Credit for Funds 3.84% 3.84%

2 Interest Expense 1.79% 2.13%

3 Total Interest Spread 1.97% 1.65%

4 Funds Credit Allocated Equity 0.10% 0.10%

5 Net Interest Spread 2.05% 1.75%

6 Non-Interest Income 0.07% 0.04%

7 Total Income 2.11% 1.79%

8 Non-Interest Expense 1.11% 0.78%

9 Pretax Profit (Loss) 0.98% 1.01%

10 Number of Accounts 1,835 363

11 Average Balance per Account $44,156 $139,199

12 Non-Interest Income per Account $5.79 $6.78

13 Annualized Cost per Account $524.28 $1,027.80

14 Annualized Net Income per Account $428.08 $1,575.55

Percent of Average Balance

38

ROI Exercise

Credit Card vs. HELOC

(dollars in thousands) Credit Card HELOC

1 New Balances $10,000 $10,000

2 Interest Income $1,000 $400

3 Cost of Funds (FTP) 150 150

4 Spread 850 250

5 Fee Income 200 50

6 Total Revenue $1,050 $300

7 Estimated net charge-offs 400 25

8 Incremental Operating Expenses 200 15

9 Net Revenue $450 $260

10 Campaign Cost $50 $50

11 Return on Investment (ROI) 900% 520%

39

ROI vs. ROE

Credit Card vs. HELOC

(dollars in thousands) Credit Card HELOC

1 New Balances $10,000 $10,000

2 Net Revenue $450 $260

3 Campaign Cost $50 $50

4 Return on Investment (ROI) 900% 520%

5 Capital Allocation $1,000 $500

6 Risk Adjusted Return on Capital (RAROC) 45% 52%

40

Customer Profitability Exercise

RAROC

Business Commercial Home Eq.

DDA Mortgage Loans

1 Credit for Funds 3.45% Interest Income 6.27% 6.32%

2 Interest Expense 0.00% Cost of Funds 3.95% 4.57%

3 Total Interest Spread 3.44% Total Interest Spread 2.25% 1.72%

4 Funds Credit Allocated Equity 0.15% Funds Credit Allocated Equity 0.39% 0.24%

5 Net Interest Spread 3.58% Net Interest Spread 2.62% 1.93%

6 Non-Interest Income 0.72% Provision for Credit Loss 0.69% 0.21%

7 Total Income 4.35% Marginal Inc (Loss) After Prov. 2.07% 1.76%

8 Non-Interest Expense 3.76% Non-Interest Income 0.10% 0.10%

9 Pretax Profit (Loss) 0.39% Total Income 2.15% 1.83%

10 Non-Interest Expense 0.66% 1.29%

11 Number of Accounts 2,525 Pretax Profit (Loss) 1.16% 0.61%

12 Average Balance per Account $18,432

13 Non-Interest Income per Account $36.88 Number of Accounts 405 1,185

14 Annualized Cost per Account $719.87 Average Balance per Account $505,002 $58,427

15 Annualized Net Income per Account $76.28 Non-Interest Income per Account $71.09 $9.82

16 Annualized Cost per Account $3,535.46 $781.60

17 Annualized Net Income per Account $6,762.85 $670.03

Customer Balances from RAROC Sample: Profits

18 Commercial Mortgage $250,000 $2,900 Capital Allocation to Customer 9.47%

19 Home Equity Loan 50,000 305

20 Business DDA 30,000 117 Profit Hurdle for 15% ROE $4,260

Total Profit $3,322 ------------------------------------->>>>>> $3,322

Customer profit over (short) of hurdle ($938)

Percent of Average Balances

Performance Measurement

StrategicManagement

Profit & ProcessImprovement

Board & Management Advisory Services

Financial Advisory

Jeffrey P. Marsico

Executive Vice President

Ph: 973.299.0300 x120

Email: [email protected]

www.kafafiangroup.com

www.jeff-for-banks.blogspot.com

mailto:[email protected]

http://www.kafafiangroup.com/

http://www.jeff-for-banks.blogspot.com/

Documents

Executive Development Program Bank Profitability … 2016/Marsico_Product_and_Custom… · Cost of Funds Total interest ... Matched Maturity - Coterminous. 26 Profitability Components