Small to mid-sized Canadian deposit-taking FIs are challenged from three different directions: Competitive landscape, level playing field and profitability skew. This deck reviews the challenges of the current operating environment for Canadian small to mid-sized FIs and provides tips on how to use strategic levers to be successful in this environment and what role can pricing analytics play.

1. Copyright©2018BBAnalytics
Copyright © 2018 BB Analytics
BankingBook Analytics:
Value-enhancement at Canadian mid-sized
banks
Sept. 2018

2. Copyright©2018BBAnalytics
Contents
Executive Summary1
3
Current State Analysis
4 Proposal 2
Proposal 1
2
2

3. Copyright©2018BBAnalytics
Contents
Executive Summary1
3
Current State Analysis
4 Proposal 2
Proposal 1
2
3

4. Copyright©2018BBAnalytics
Executive summary
Value enhancement at Canadian mid-sized FIs
o Proposal 1: IRB migration:
§ Banks that migrate to IRB do well and create capital at a rapid rate
o Proposal 2: Pricing discipline improvement:
§ Re-aligning performance metric with IFRS 9 model’s output (Expected
Credit Loss) for loan pricing
• BankingBook Analytics (BBA) can assist with design and development of
both initiatives. In the following sections, we provide summary details on
motivation for developing value drivers
• BankingBook Analytics is a Toronto-based predictive analytics firm that develops
risk and capital management applications, integrated decision-making systems
and process automation
4
Small-mid sized Canadian banks are disadvantaged by disproportionately
higher risk weight of the assets that they carry, resulting in much slower rate
of capital accretion
• All other things being equal, higher risk-weighted assets, as applied under
the Standardized Approach of Basel II, require require higher capital
attribution - perpetuating the size advantage for ‘Big 6’ banks
• So what can the small- mid sized FIs do to overcome this challenge

5. Copyright©2018BBAnalytics
Contents
Executive Summary1
3
Current State Analysis
4 Proposal 2
Proposal 1
2
5

6. Copyright©2018BBAnalytics
Asset distribution for “non-captive” Canadian banks
Top-6 Canadian banks control 95.6% of aggregate market
assets*, while remaining 4.4% is managed by 18 banks
6
• Total assets under management at top-6 Canadian banks are approx. $4.7Tn, representing 95.6%
of the aggregate banking assets
o Assets managed by the remaining 18 banks are at c. $207.7 Bn
0
1
2
3
4
5
6
7
$35M-
100M
$100M-
400M
$400M-
800M
$800M-
1.7B
$1.7B-6B
$6B-18B
$18B-51B
$51B-144B
$144B-
490B
$490B-
1.2T
• CIBC
• BMO
• BNS
• TD
• RBC
• National
Bank
• Equitable Bank
• Home Trust
• Vancity Community
Investment Bank
• Canadian Western Bank
• Laurentian Bank of Canada
• B2B Bank
• Concentra Bank
• Meridian Bank
• VersaBank
• HomEquity Bank
• CS Alterna Bank
• UNI Financial
Cooperation
• General Bank
• Industrial And Commercial
Bank of China
• KEB Hana Bank Canada
• First Nations
Bank of
Canada
• Street
Capital
• DirectCash
Bank
#ofbanks
$35MM $51Bn $52Bn $1.2TN
‘Big 6’ banks18 banks
*includes overseas assets also

7. Copyright©2018BBAnalytics
Disparity in capital accretion
Is higher regulatory capital at small to mid-sized banks preventing
the growth of new organic capital
7
9%
4.40%
7.50%
6.20%
9.45%
12.50%
7.98%
0 1 2 3 4 5
VersaBank ~
RBC ~
TD ~
CIBC ~
National ~
Capital consumption zone* Capital creation zone
Laurentian ~
CWB ~
CET1 in %
(estimates)
Size of bubble = Risk Weighted Assets (in C$M)

8. Copyright©2018BBAnalytics
This size disparity is further exacerbated by lower lower returns
on risk-adjusted basis
8
Banks Risk-adjusted return on capital
National 25.66%
TD 18.72%
Scotia 18.24%
RBC 18.23%
BMO 14.49%
CIBC 13.13%
CWB 15.40%
Laurentian 9.03%
VersaBank 4.55%
Average
risk-
adjusted
return:
18.1%
Average
risk-
adjusted
return: 9.6%
Domestic Systemically
Important banks
Non-DSIBs

9. Copyright©2018BBAnalytics
Small to mid-sized banks also exhibit wide disparity in pricing
for similar levels of risk
9
Pricing of Term Loans
Loans booked Oct-Dec 17
• Possible explanations for such variability
is:
o Client/transaction characteristics
o Data/parameter issues
• Several possible approaches can be
applied to improve pricing
o Re-alignment of performance
metrics
o Increased understanding of
transaction and relationship value
o Inclusion of internal and external
benchmarks in pricing tools
o Optimised trade-off with
probability of attrition
o Approval processes for pricing
below certain floors
Margin
(GrossmarginlessCoF)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
0.0% 0.0% 0.1% 1.0% 10.0%
ECL = PD x LGD (log scale)
RoRWA ~ 3%2
RoRWA = ~1%2
Case study Current state of pricing at mid-
sized FIs
BBA’s proprietary research
• In most cases the primary driver is simply poor pricing discipline and
choice of performance metric

10. Copyright©2018BBAnalytics
Contents
Executive Summary1
3
Current State Analysis
4 Proposal 2
Proposal 1
2
10

11. Copyright©2018BBAnalytics
Proposal 1: IRB migration
IRB approval is a long and drawn out process and requires extensive
resources
11
• Kicks off when an institution
submits an initial self-assessment
(Gap Analysis) against the
applicable IRB minimum
requirements
• This phase involves various
activities that are the ‘ground-
clearing’ work
• Phase 1 is organized in two parts:
o Part 1A: Institution initial
self-assessment (Gap
Analysis) and associated
project planning
o Part 1B: Institution
proposed rollout plan for
IRB implementation
Phase 1: Monitoring
of implementation
efforts
Phase 2: Formal
application and
preparation for
‘meaningful’ parallel
reporting
Phase 3:
‘Meaningful’ parallel
reporting and
completion of OSFI
review for approval
Phase 5: Monitoring
of ongoing
compliance
Phase 4: Approval
for Pillar 1 credit risk
capital purposes
• To prepare for IRB implementation, an institution is required to
conduct Gap Analysis:
o Particular emphasis on those requirements set out in the
Rating System Design and Operations sections of the
minimum requirements (i.e., Sections 5.8.3 and 5.8.4 of
the CAR Guideline A-1)
o CAR Guideline
• The number of rating systems employed and their respective
applications
• The measures of materiality assumed, including a measure of
“Qualifying Assets” , a list of waivers and exemptions
OSFI approval process

12. Copyright©2018BBAnalytics
Case study: IRB lets banks create capital at a higher rate
12
Size of bubble = portfolio size (in C$M)
Risk adjusted capital (in %)
Portfolio 2
Portfolio 1
Pre-IRB Post-IRB
Portfolio 2
Portfolio 1
Capital consumption
zone
Capital
creation
zone
Capital
consumption
zone
Capital creation zone
• Capital consumption or creation is a function of Return/Economic Capital
o Standardized Approach requires approx. 3x risk weighted assignment vs. IRB
• Value greater than 1 represents market expectation of growth and vice-versa
*Assumption: 10-year Government of Canada bond used as risk-free rate, beta sourced from Yahoo Finance, and
expected market return estimated by average ROE of Canadian banks from 2016 annual reports
Risk adjusted capital (in %)

13. Copyright©2018BBAnalytics
Ceteris paribus, substantial size of the prize awaits when banks
implement IRB models
FIRBCapitalRatio ReductioninRWA StandardizedCAR
BBA research
Example capital savings
Comments
§ Globally, the introduction of the Basel 2 FIRB
has led to an increase in the Tier 1 ratio of
~4%
§ This creates a buffer over the minimum
required capital of the actual Tier 1 ratio
o 4% of capital implies increased lending
opportunity, e.g., approx.12.5x of
available capital
o Improved margins due to increased
solvency, lowering the cost of
borrowing
How do we translate
capital savings and its
optimal utilization into the
share price growth?
7%
4%
11%
13

14. Copyright©2018BBAnalytics
Contents
Executive Summary1
3
Current State Analysis
4 Proposal 2
Proposal 1
2
14

15. Copyright©2018BBAnalytics
Proposal 2: Improved pricing discipline by applying Expected
Credit Loss metric
15
Standalone Excel
model
Automation IFRS 9 Application
• Production
environment in
Excel is not
designed for
frequent and heavy
data processing
• Prone to
operational risk and
errors
• Significant FTE
involvement –
maker/checker
• Lacks database
connectivity
• Online production
environment is
stable and
customized
• Cuts down FTE
times by 2/3rd and
creates savings
Current state
• Application in
loan pricing,
provides
competitive
advantage
• Pricing model
more accurate
providing multi-
year view of
returns
BBA’s assistance theme

16. Copyright©2018BBAnalytics
Re-aligning pricing with ECL metric would increase the pricing
visibility, resulting eventually into higher value-add
16
-125
-100
-75
-50
-25
0
25
50
75
15030
RWA 20,000
Economic capital 360
Annual revenue 120
Possible
actions
Cumulative value creation
C$MM
Number of corporate customers
200
• Prioritise/penetrate
• Defend against poaching
10050
Value adding
• Cross-sell higher margin products
• Reduce Marketing time where low
potential for value growth
RWA 30,000
Economic capital 620
Annual revenue 110
Value neutral
• Reprice/restructure/release if no
potential for improvement
• Subsidise explicitly/emerging
relationships with high revenue
potential
RWA 30,000
Economic capital 960
Annual revenue 80
Value destroying
Value destroying
Value adding
Value neutral
Case study

17. Copyright©2018BBAnalytics
Application of IFRS 9 ECL in pricing would help fine tune
strategic pricing
BBA’s IFRS 9 application helps clients improve pricing disciplineStrategicobjective“profitability”
Strategic objective “growth”
Overall strategy:
Profitability (quality) is more important
than volume
Profit strategy:
Achieve high margins
Overall strategy:
Healthy, profitable growth
Profit strategy:
Optimise overall client profitability
Overall strategy:
Growth, growth
Profit strategy:
Volume at all costs
Prerequisite: Differentiation criteria
in brand and products
Prerequisite: Sophisticated
analysis capabilities, relationship
Management and tools
Prerequisite: Low cost/cost optimised
production processes
Profit rate reference
Risk costs
Highest
achieved profit
Market rate of
return
bps
“Minimum”
break-even
Hurdle rate
Target corridor
Best peer
return
Overall strategy:
Conservative growth
Profit strategy:
Focus on quality, ‘ability to say no’
Prerequisite: Credit factory, Low
cost production
17

18. Copyright©2018BBAnalytics
Copyright © 2018 BB Analytics
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