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Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation

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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 …

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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  • 1. 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
  • 2. 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
  • 3. Aim and Contribution of Our Research
    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
    • 4. Emphasize the importance of reporting forward-looking metrics
    • 5. Propose customer equity reporting (CER) and the customer equity sustainability ratio (CESR) as potential means to increase transparency in financial statements
    • 6. Provide stakeholders with valuable information about the long-term value of a customer base
    • 7. Argue that more forward-looking metrics might have diminished the devastating consequences of the current financial crisis
    3
  • 8. Securitization in Non-Financial Businesses (1/2)
    Soccer club realizes earnings from ticket sales
    soccer entertainment
    earnings from ticket sales
    $100,000,000
    soccer club
    soccer club fans
    • 5 years considered; 20 games per year; 50,000 spectators per game; $20 per ticket
    • 9. Total earnings of the soccer club from ticket sales: $100,000,000 ($20,000,000 each year)
    4
  • 10. Securitization in Non-Financial Businesses (2/2)
    Soccer club transfers its future ticket sales to a bank
    soccer entertainment
    one-time earnings from securitization
    $75,815,735
    soccer club
    earnings from ticket sales over next five years
    soccer club fans
    bank
    $100,000,000
    • Discount rate: 10%
    • 11. Discounted net present value of total earnings: $75,815,735
    5
  • 12. European Union’s Trouble with Greece
    6
    Banks went to Athens to pitch complex products to defer debt.
    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.
    Story, Landon, and Schwartz (2010), "Wall Street Helped to Mask Debt Fueling Europe’s Crisis", Wallstreet Journal, February 14
  • 13. Securitization in Financial and Non-Financial Industries
    (e.g., Bermes 2011; Bessler 2007; Jobst 2002)
    7
  • 14. Basic Idea of Securitization in Banking (1/2)
    Traditional banking business is to borrow and lend money (buy and hold)
    bank
    loan granter
    t0: loans
    Non-securitization
    • Loans (mortgages, business financing, consumer loans etc.) are offered mainly to bank’s own customers
    • 15. Amortization can be paid e.g. annually or at the end of the contract period (bullet loan) depending on the loan structure
    • 16. Interest is paid by borrowers constantly (often monthly or annually) on loan volume outstanding
    • 17. Banks earn money from the margin between the interest rate of the loan and the refinancing costs minus provisions for expected loan losses
    • 18. Banks receive the interest margin constantly over the lifetime of the loan contract (for bullet loans)
    t1 to tn: interest
    and amortization
    loan borrowers
    8
  • 19. Basic Idea of Securitization in Banking (2/2)
    Traditional banking business is extended to securitization (originate and distribute)
    SPV
    investors
    bank
    loan granter
    trustee
    t0: price for
    loan claims
    t0: loans
    t0: price for
    securities
    t0: loan claims
    t0: loan claims
    t0: securities
    Securitization
    • Loans are sold to special purpose vehicles (SPV) and therewith handled outside the bank’s balance sheet
    • 20. Loans are packed and structured into investment tranches with different underlying risk levels
    • 21. Tranches are distributed to investors
    • 22. A trustee collects interest and amortization cash flows from borrowers and redirects them to investors
    • 23. Investors face the risk of loan defaults
    t1 to tn: interest
    and amortization
    t1 to tn: interest
    and amortization
    loan borrowers
    9
  • 24. Underestimated Risk in Securitized Assets
    “First round“ collateralized debt obligations (CDO)
    Securitization
    “Second round” collateralized debt obligations (CDO2)
    Securitization
    10
  • 25. 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)
    • 26. Coval, Jurek, and Stafford (2009)
    • 27. Franke and Krahnen (2008)
    • 28. Lockwood, Rutherford, and Herrera (1996)
    • 29. Luo, Tang, and Wang (2008)
    • 30. Purnanandam (2009)
    Through securitization, ...
    • Banks can reach stronger liquidity positions
    • 31. Banks can easier fulfill regulatory requirements such as Basel II/III
    E.g.:
    • Ambrose, Lacour-Little, and Sanders (2005)
    • 32. Calem and LaCour-Little (2004)
    • 33. Jones (2000)
    • 34. Purnanandam (2009)
    • 35. Twinn (1994)
  • Banking Example: Assumptions and Calculation Basis
    • We distinguish between a non-securitizing and a securitizing bank
    • 36. The banks each issue a five-year loan volume of $100,000 to customers at the beginning of each year
    • 37. The annual net interest margin of the loans is 1% (5% interest rate; 3.5% refinancing expenses; 0.5% loan loss provisions)
    • 38. No other deductions or costs occur
    • 39. Discount rate is 10%
    • 40. The non-securitizing bank gets the interest income at the end of each year
    • 41. 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
    • 42. Customer equity is valued as of the end of each year
    • 43. Equity is $30,000
    • 44. We analyze two cases:
    • 45. Distribution case: The banks pay out all of their earnings as dividends at the end of each year
    • 46. Reinvestment case: The banks reinvest the earnings at a return rate of 10%
    12
  • 47. Banking Example: Non-Securitizing Bank
    13
  • 48. 14
    Banking Example: Securitizing Bank
  • 49. 15
    Banking Example: Effects of Securitization on Earnings (Distribution Case)
  • 50. 16
    Banking Example: Effects of Securitization on Return on Equity (Distribution Case)
  • 51. 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)
    • 52. CER publishes detailed customer structures with related earnings and costs in absolute numbers
    • 53. CER can issue a forward-looking statement
    Customer Equity Reporting(CER)
    Newly developedCustomer EquitySustainability Ratio(CESR)
    • CESR compares the likely future earnings of the existing customers to current earnings
    • 54. CESR identifies shifts in value realizations over time
    • 55. CESR reports the sustainability of the bank’s earnings as a relative number in a simple and substantial way
    17
  • 56. Customer Equity Sustainability Ratio (CESR)
    CESR is a new metric to quantify the intensity of long-term value creation
    • Defining CESRjas 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)
    • CESR for all current customers is:
    (3)
    (2)
    18
  • 57. Relationship Between Customer Equity (CE) and Customer Equity Sustainability Ratio (CESR)
    19
    CE (high)
    Short-TermProfit Realizationwith a StrongCustomer Base
    Long-TermValue Creationwith a StrongCustomer Base
    CESR (low)
    CESR (high)
    Short-TermProfit Realizationwith a WeakCustomer Base
    Long-TermValue Creationwith a WeakCustomer Base
    CE (low)
  • 58. 20
    Banking Example Revisited: Effects of Securitization on CE (Distribution Case)
  • 59. 21
    Banking Example Revisited: Effects of Securitization on CESR (Distribution Case)
  • 60. 22
    Empirical Study About Transparency of Securitization in Banks’ Financial Reports (1/2)
  • 61. 23
    Empirical Study About Transparency of Securitization in Banks’ Financial Reports (2/2)
  • 62. Empirical Study of Countrywide:General Information
    Countrywide was the market leader in mortgage banking
    • Countrywide Financial Corporation (CFC) was the U.S. market leader in mortgage lending and origination between 2004 and 2007
    • 63. Countrywide provides a detailed view of the shift from long-term value creation to short-term profit realization
    • 64. Countrywide was heavily engaged in subprime mortgage-backed securities (MBS) transactions
    • 65. Countrywide needed a rescue from Bank of America in February 2008
    • 66. As a subsidiary of Bank of America, Countrywide no longer publishes its own financial statements, so our analysis comprises 1998-2007
    24
  • 67. 4
    Empirical Study of Countrywide:Securitization of Mortgage Loans
    Total Mortgage Loans Volume (in m USD)
    468,172
    499,301
    123,969
    68,923
    415,634
    66,740
    92,881
    363,364
    434,864
    251,901
    4%
    5%
    96%
    95%
    90%
    89%
    86%
    86%
    82%
    72%
    65%
    59%
    2005
    2001
    2006
    2000
    1999
    2007
    1998
    2004
    2003
    2002
    % of Volume of Mortgage Loans Hold
    % of Volume of Mortgage Loans Sold
    25
  • 68. Empirical Study of Countrywide:Earnings Structure
    26
  • 69. 27
    Empirical Counterfactual Analysis of Countrywide: Total Earnings
  • 70. 28
    Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings
  • 71. 29
    Empirical Counterfactual Analysis of Countrywide: Customer Equity
  • 72. Empirical Counterfactual Analysis of Countrywide: CESR
    0.673
    Factor 3.2
    0.210
    30
  • 73. 31
    Empirical Counterfactual Analysis of Countrywide: Factors in CESR
  • 74. 32
    Securitization in Industries Outside Banking (1/2)
  • 75. 33
    Securitization in Industries Outside Banking (2/2)
  • 76. Discussion and Conclusion
    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
    • 77. CER and CESR as forward-looking customer metrics provide stakeholders with transparency about the long-term value of a firm’s current customer base
    • 78. CESR can better identify shifts in value realizations over time
    • 79. CESR reports the sustainability of the firm’s earnings in a simple and substantial way
    • 80. CER and CESR provide insights into how investors and firms can be supported to avoid some of the challenges of a future financial crisis
    34
  • 81. Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation
    Need more Information? Contact one of us!
    35