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Relationship Profitability Is Back!

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When economic cycles take a directional turn, some products become more valuable to a financial institution. Speakers discussed relationship profitability when pricing a new opportunity and how deposits have become more valuable than they have been in the past.

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Relationship Profitability Is Back!

  1. 1. John Robertson – Senior Business Process Architect Relationship Profitability Is Back!
  2. 2. What fuels the returns?—critical attributes • Interest rates • Cost of funds/costs of deposits • Non-interest income/expense • Spreads – Gross margin – Net interest margin – Net income
  3. 3. Key measures • Gross margin/revenues – Interest income plus fees, less cost of funds • Net interest margin (NIM) – Interest income less cost of funds • Net income (pre-tax) – Includes interest income plus fees less cost of funds less non-interest expense less risk expense • Net profit after tax
  4. 4. Critical indicators • Return on assets (ROA) • Return on equity (ROE) • Risk-adjusted return on capital (RAROC)
  5. 5. The importance of critical indicators • Consistency in comparing business loan returns • Provide a scale to use in managing customer relationships • Provide risk-adjusted view of loan and relationship returns • Enhance lender knowledge and ability to consider loan structure tradeoffs • Enable risk-adjusted and profit-based reporting
  6. 6. Return on assets (ROA) • An indicator of how profitable a loan is relative to its total outstanding balance • How efficient management is at using its assets to generate earnings • ROA = net profit after tax/average asset
  7. 7. Return on equity (ROE) • The amount of net income returned as a percentage of shareholders equity • How much profit a loan generates with the money shareholders have invested • ROE = ROA/equity
  8. 8. Risk-adjusted return on capital (RAROC) • Framework for analyzing risk-adjusted financial performance and providing a consistent view of profitability across businesses • Economic capital is a function of market risk, credit risk, and operational risk • RAROC = ROA/economic capital • RAROC = ROA/value at risk (aka VaR)
  9. 9. Deposits value added
  10. 10. Funds transfer pricing (FTP) Clients Asset generators Mismatch unit Liability generators Clients Funds transfer pricing charge Funds transfer pricing charge Equity capital • Loans • Securities • Cash • Fixed assets • Intangibles • Deposits • Wholesale funds • Preferred shares Interest rate paid Funds Funds Funds Funds Interest rate paid Interest rate earned on capital Equity credit rate ECR1 ECR1
  11. 11. FTP should be consistently applied • Balance sheet and liquidity management – FTP assumptions should be closely synchronized with A/L modeling assumptions; in turn, both should be consistent with investment and Treasury funding decisions • Performance measurement – Results should allocate accurate funds charges and credits to the entire balance sheet • Product pricing – When a new product is to be offered, its interest rate characteristics should be fully understood to derive an appropriate FTP rate
  12. 12. FTP rate trends
  13. 13. 2.80% 2.870% 3.080% 3.310% 1.000% 1.500% 2.000% 2.500% 3.000% 3.500% 4.000% Commonly-used FTP Rate Migration 3 Yr 5 Yr 7 Yr 10 Yr
  14. 14. 2.3200% 2.2400% 1.9200% 1.6200% 1.3900% 1.2000% 1.1100% 1.0300% 0.8900% 0.0000% 0.5000% 1.0000% 1.5000% 2.0000% 2.5000% O/N 1 Years 2 Years 3 Years 4 Years 5 Years 6 Years 7 Years 10 Years FTP Rate Change from 2015 - 2019
  15. 15. Administrative expenses deposits versus FTP rate (2/27/19) Product DDA (5-7 years) MMDA (3 years) Savings (5 years) CDs (match maturity) FTP rate 2.87-3.08% 2.80% 2.87% 2.80-3.31% Admin. Expense* 3.00% 1.50-2.50% 1.50-2.50% >1.00% *Net of fees
  16. 16. Relationship profitability
  17. 17. Reasons banks use relationship profitability • Margin compression • Relationship management • Risk management • Performance measurement • Return on shareholders equity • Measurement consistency • Business and marketing strategy
  18. 18. Deposits: breakdowns and trends
  19. 19. 70.94 71.83 71.18 71.22 70.13 71.24 71.36 71.63 71.17 72.27 72.31 72.32 16Q1 16Q2 16Q3 16Q4 17Q1 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3 18Q4 Loans to deposits %—past 12 quarters
  20. 20. Loans to deposits %—past 7 years
  21. 21. Interest expense mix—past 10 years
  22. 22. Analytics can identify your potential exposure
  23. 23. The rate of attrition If a financial institution does not engage effectively with a customer during the initial onboarding period they risk a higher rate of attrition. The top 100 FIs see a 25 to 40% attrition rate during the first year from signing on a new customer. What is your attrition rate?
  24. 24. Ask yourself
  25. 25. Analytics can... • Support business decisions based on rich, customized data intelligence • Understand which accounts and relationships are most profitable • Identify, plan, execute, and track sophisticated marketing campaigns Detailed Accurate Timely
  26. 26. Immediate insights
  27. 27. New competitors for the millennial’s money: fintechs
  28. 28. New competitors & the raid on consumers Percent of market share that full-service banks in North America could lose to new digital competitors by 2020 35% Source: Accenture, 2016 – Includes consumer, small business and commercial accounts
  29. 29. The millennials—who are they?
  30. 30. 31% of customers would consider Google, Amazon or Facebook if they offered such services. 47% of customers said a loan application should take no longer than a day 75% say that fintech gives them more power over their finances than banks Challenges that financial institutions must address
  31. 31. Challenges to engage millennials 1. Escaping the commodity sale 2. Creating digital operational excellence 3. Avoiding possible disruption within the FI 4. Growing through actionable insights from analytics
  32. 32. Escaping the commodity sale Local Expertise Years of Experience Features “The right financing tools can streamline your cash flow.” “Our decisions are made locally and are tailored to your needs.” “[Our bank] offers local expertise in all aspects of…solutions…” “[Our bank] is a community-focused regional bank.” “…in addition to traditional credit and financing solutions.” “For the last 165 years, our customers come first.” “First more than 100 years…” “Why bank with us? We have over 135 years of experience.” “Why [our bank]? Our Experience, Strength and Stability.” “A small business checking account that offers more control and access.” “Substantial experience, with many team members averaging 15 to 20 years.”
  33. 33. Avoid being a commodity 93 YEARS TO BUILD 610,000 ROOMS, 88 COUNTRIES 4 YEARS TO AMASS 650,000 ROOMS, 192 COUNTRIES
  34. 34. Replaced value: tech & convenience $23 Billion Market Capitalization $31 Billion Venture Capital Funding
  35. 35. FinTech disruptors
  36. 36. In the news…
  37. 37. Disrupting within the bank
  38. 38. Remember the value proposition to counter the disruptors “If you can prove that you are delivering value and ease to customers, they will tend to stay with you” Jeremy Takle, Head of Barclays’ U.S. digital consumer bank
  39. 39. Concluding remarks/closing • Rates have been rising • Indications are rates will continue to increase • FTP values will enhance relationship returns • Use analytics to understand your portfolio • New disruptors will begin to compete for consumer products • Deposits are “gold” even when they aren’t worth much
  40. 40. Questions?
  41. 41. Thank you! John.Robertson@bakerhill.com

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