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Why Knowing Profitability Is the Key to Success at Your Institution

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Most financial institutions don’t understand that the majority of their relationships are not profitable. This results in poor strategic planning especially when dealing with issues with the balance sheet. Senior Management has to understand and deal with different types of risk, along with income statement stagnation in these times of rising interest rates.

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Why Knowing Profitability Is the Key to Success at Your Institution

  1. 1. Jeff Dwornicki – Baker Hill Scott Sills – Citizens National Bank of Meridian Why Knowing Profitability is the Key to Success at Your Institution
  2. 2. Agenda • Culture • Environment • Process • Understanding profitability • Pricing • Summary
  3. 3. Who am I? • The guru of profitability for Baker Hill NextGen® Analytics • Design fund transfer pricing for all clients • Build transactional allocations for NII and NIE • For 14 years at Baker Hill, worked with CFOs to build the financial rules for their database • For 14 years, translated financial rules to Marketing to help build campaigns and matrix programs
  4. 4. My Co-presenter • Scott Sills is currently serving in his 28th year with Citizens National Bank, and has achieved his Certified Financial Marketing Professional certification. • Sills has served in a number of capacities over his career with the Bank including leadership positions in the Meridian, Waynesboro and Hattiesburg markets as well as serving as the Bank’s North MS Regional President before moving into the role of Chief Marketing Officer. • Citizens National Bank is an independent, Mississippi- owned community bank, which has 26 bank locations For 14 years, translates Financial rules to Marketing to help build campaigns and Matrix programs. • The Bank has assets in excess of $1.3 billion and manages over $1 billion in its Wealth Management Division, which is committed to assisting clients with the accumulation, preservation and transfer of wealth.
  5. 5. Banking culture
  6. 6. Banking culture • Wait for growth to walk through the door Banking hours • Drive growth by selling and cross – selling anything to everyone who comes through the door Sales culture • Maximize profitable growth by selling and up-selling profitable products and target the correct markets Profitability
  7. 7. Typical bank planning • Use last year’s results for this year’s financial plan • Adjustments made depending upon environment • Provide marketing and sales goals based on balance sheet targets • Promotions and products built to meet sales goals • Track quarterly relative to balance sheet as the bottom line
  8. 8. Typical bank planning • Sales culture measurements – Simple sales volume – Simple cross-sell ratio – Simple deposit and/or loan growth • Sales culture methodology – More is better – Campaign to all – Silver bullet products – Price for volumes; reward for volume
  9. 9. Banking environment
  10. 10. Profit risk • Is the total profit for our top 10% most profitable relationships (households) divided by total profit of the institution • Most financial institutions’ are about 200 – 400% • Very few are less than 200%
  11. 11. Profitability risk – top 10% Percent​ Number of Relationships​ Total Profitability​ Concentration​ 1% 281 $6,135,006 277% 2% 281 $1,296,752 59% 3% 281 $813,830 37% 4% 281 $581,217 26% 5% 281 $451,285 20% 6% 281 $368,878 17% 7% 281 $302,031 14% 8% 281 $252,220 11% 9% 281 $203,199 9% 10% 282 $166,852 8% Top 10% 2811 $10,571,270 478% Institution 28,110​ $2,211,039 100%
  12. 12. Profit risk – institution profit vs. top 10% profit 5.6 26.2 6.9 33.0 7.7 38.0 2016 2016 2017 2017 2018 2018 Profit Risk InMillions($)
  13. 13. Net Income stagnation Non interest income $19.8M (Dec 2018) Non interest expense $42.8M (Dec 2018) Net interest margin $36.2M (Dec 2018) Net income $13.2M (Dec 2018) Net interest margin $31.7M (Dec 2017) Non interest income $18.6M (Dec 2017) Non interest expense $37.5M (Dec 2017) Net income $12.8M (Dec 2017)
  14. 14. Income statement stagnation Unprofitable 70% Profitable 30%
  15. 15. Profitability – service Product/Service​ Number of Accounts​ Total Profitability​ Concentration​ Mortgages​ 1,592​ $1,966,884 89% Home Equity Loans/Lines​ 1,889​ $937,630 42% Money Market​ 1,476​ $780,341 35% Interest Checking​ 2,787​ $624,687 28% Business Loans​ 354​ $502,561 23% Auto Loans​ 4,629​ $435,138 20% Business Checking​ 1,678​ $181,216 8% Retirement​ 2,462​ $64,023 3% Investments/Insurance​ 2,042​ -$61,919 -3% Certificates of Deposit​ 5,796​ -$196,668 -9% Credit Cards​ 3,278​ -$405,223 -18% Electronic Services​ 23,524​ -$616,835 -28% Free Checking​ 15,894​ -$949,738 -43% Savings​ 11,590​ -$1,051,058 -48% Total​ 78,991​ $2,211,039 100%
  16. 16. Rising yield curve 0.00 0.05 0.10 0.15 0.20 0.25 2016 2017 2018 Cost of Funds 3.32 3.36 3.40 3.44 3.48 3.52 3.56 2016 2017 2018 Yield
  17. 17. Balance sheet – loans to deposits 76.7% 82.7% 89.4% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 2016 2017 2018
  18. 18. Why we need to know about our profitability • Profit risk • Income statement stagnation • Most customers are unprofitable
  19. 19. Getting to big data
  20. 20. Inputs to data driven planning • Complete allocation of the GL • Income statement for every account • Full allocation of non-interest income • Full allocation of non-interest expense • Full allocation of net interest income (margin) through funds transfer pricing
  21. 21. Inputs to data driven planning • Income statement for all customers/members/relationship • Unique, not average profitability • Fees go to accounts who create the fee, no guessing • Rank from most unprofitable to most profitable
  22. 22. Building the database Systems of Record General Ledger BH Analytics Service Branch Region Institution Individual Relationship (Household) Customer/ Member Product Group Product Allocation Rules Account Level
  23. 23. Identify • What does the strategic plan call for? • In need of deposits or loans? • Concerns about customers leaving? • Which products are selling well now? • Which products are profitable? • Who are the profitable consumers?
  24. 24. Create a plan • Choose the products based on profitability • If unprofitable, use what-if and stratification research to determine interest rate and average balance to reach targeted profitability • Target customers with propensity and capacity • Optimize market channel based on ROI and effectiveness • Consider frequency requirements during campaign development
  25. 25. Review and manage Are we hitting targets – profitability of campaign, volume, and cost? Are we achieving our goals? Why and how do we change if we need or want to be more successful?
  26. 26. Understand your profitability and products
  27. 27. Identify the need • In need of deposits & selling loan portfolios • Want to expand margin • High interest reward checking and reverse MM hitting the market • What-if showed closed reward checking profitable at average balance of $15,000
  28. 28. Prepared for a promo CD, but… • Re-opened reward checking product • High interest rate up to $25,000 • 12 debit card POS • eStatements • Direct deposit of $100 or more • Log in online once a month
  29. 29. Reward checking • Re-open the product to new customers • Big attractive post on website • Taught tellers to interface about the product • Mailing involved with newsletter • Onboard to new customers
  30. 30. Create loyalty with a lower cost of fund product • Cannibalization on interest checking product • No cannibalization on free checking • Reward checking has greater cross-sell • Reward checking is much more profitable • $54 million in new checking balances • Doubled the profitability of their retail checking line in one year
  31. 31. Profit review – up selling checking • Interest checking & reward checking are “stickier” • Both encourage higher balances • Reward checking creates interchange • Low cost to upsell and cross-sell • Higher balances can often trump interest rates • Customer much more loyal • Creates opportunity for additional deposit gathering
  32. 32. Profitability – checking Product Interest Rate Average Balance Average Profit Free Checking 0.00 $995 -$7 Interest Checking 0.20 $4,747 $90 Reward Checking 2.50 $33,857 $599
  33. 33. Understanding your profitability and pricing
  34. 34. Profitability review – business loans Loan Product Code Number of Accounts Number of Relationships Total Balances Average Balance Per Account Weighted Average Rate Weighted Avg. Maturity in Months Annualized Average Profit Per Account Business Loan/Line 4,560 3,080 $1,255,208,117 $275,265 5.09 66.2/ (4,003) $2,414 Commercial Ag Land Loan 6010 201 196 $24,481,038 $121,796 4.87 252.0 /(192) $960 AG RE 365/3601B LN-30 38 36 $7,307,551 $192,304 4.99 143.1 /(38) $1,275 AG RE 365/365 1B LN-31 6 6 $413,013 $68,835 4.76 26.1 /(6) $725 AG RE 30/360 1B LN-32 155 152 $16,379,041 $105,671 4.8 311.0 /(146) $883 AG RE 30/360 1B LN-33 2 2 $381,433 $190,717 5.45 51.0 /(2) $1,722 Commercial Jr Lien 6025 5 5 $364,286 $72,857 4.68 99.7 /(4) $9,860 CML RE 1C2B 365/365 LN-34 1 1 $137,147 $137,147 4.05 119.4 /(1) $11,097 CML RE 1C2B 365/360 LN-36 4 4 $227,139 $56,785 5.06 87.8 /(3) $9,550 Commercial Ag Loan 6030 86 75 $6,230,369 $72,446 6.30 11.2 /(78) $1,016 Agri 365/360 3 LN-29 86 75 $6,230,369 $72,446 6.30 11.2 /(78) $1,016 Commercial Warehouse Lending 6035 2 2 $9,561,616 $4,780,808 3.95 4.7 /(2) $5,071 Warehouse Lending LN-WL 2 2 $9,561,616 $4,780,808 3.95 4.7 /(2) $5,071 Commercial & Industrial 6040 1,959 1,329 $187,272,445 $95,595.94 5.40 34.1 /(1,702) $647 CML 4A 365/365 LN-1 58 50 $7,995,094 $137,846 5.16 20.6 /(23) $998 CML Loan 4A 365/360 LN-3 1,901 1,191 $179,277,350 $94,307 5.42 34.7 /(1,679) $632 Commercial MF & Land 6041 308 249 $160,274,754 $520,373 5.52 38.4 /(256) $7,917 COMML 1A2 365/365 LN-10 11 11 $3,200,531 $290,957 5.02 128.4 /(6) $2,044 COMML 1A2 30/360 LN-11 7 7 $54,629 $7,804 5.25 55.7 /(3) ($79) COMML 1A2 365/360 LN-12 290 232 $157,019,594 $541,447 5.53 36.6 /(247) $8,333 Commercial Revolving 6044 13 $13 $3,060,198 235400 6.58 5.3 /(13) $6,398 CML RE 1C1 365/360 LN-54 13 $13 $3,060,198 235400 6.58 5.3 /(13) $6,398
  35. 35. Deposit and loan portfolios 7% 1% 1% 2% 11% 3% 6% 65% 1% 4% 22% 16% 6% 9% 22% 21% 3% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Deposits Loans IOLTA & Escrow Business Checking Retail Checking Retail Savings Public &Public & NP Business Savings Retail Money Market Deposit State & Political Loans Home Equity Loan/Line Business Consumer SBA Lending ODLOC
  36. 36. Pricing profitability – business loans • Retail loans account for 24% of the loans • Retail deposits account for 56% of total deposits • Need to engage retail customers for loans • Need to engage business customers for deposits
  37. 37. Profitability review – business loans Loan Product Code Number of Accounts Number of Relationships Total Balances Average Balance Per Account Weighted Average Rate Weighted Avg. Maturity in Months Annualized Average Profit Per Account Business Loan/Line 187 140 $57,561,186 $307,814 4.65 130.9/ (168) ($4,726) Business Comm'l RE Loan Fixed Rate 6040 46 38 $13,993,293 $304,202 4.24 140.2 /(46) ($5,304) INVESTMENTPROPERTY L107 11 11 $1,059,754 $96,341 3.74 297.2 /(11) ($4,273) BUS FIXEDHOME EQUITY L109 2 2 $300,212 $150,106 5.63 47.5 /(2) ($3,341) Commercial Fixed Mort. L110 5 5 $1,280,687 $256,137 4.67 73.9 /(5) ($3,710) Commercial Participation L111 4 2 $1,518,755 $379,689 4.64 121.0 /(4) ($5,043) Commercial Fixed Balloon L112 10 9 $1,597,507 $159,751 5.30 29.7 /(10) ($4,491) Senior Housing Rehab L121 1 1 $14,152 $14,152 4.25 36.6 /(1) ($4,826) BSR L129 4 3 $250,358 $62,589 5.29 27.1 /(4) ($3,113) 3/1 Investment ARM Business L130 2 2 $125,738 $62,869 3.44 319.4 /(2) ($5,131) Participation Commercial ARM L136 7 4 $7,846,130 $1,120,876 3.87 160.5 /(7) ($11,305) Business Comm'l RE Loan Variable 6050 58 49 $36,599,418 $631,024 4.81 134.7 /(51) ($3,586) Commercial ARM L132 31 28 $11,876,577 $383,115 5.16 133.3 /(31) ($2,299) Bus LOC Vari Unsecured L169 5 5 $4,665 $933 9.68 0 ($5,754) Business LOC Var Secured L170 2 2 $69,530 $34,765 5.96 0 ($5,362) Commercial ARM - Fixed L175 2 2 $499,155 $249,577 7.09 55.4 /(2) $1,682 Commercial ARM - Balloon L176 18 13 $24,149,491 $1,341,638 4.58 137.1 /(18) ($5,590) Business Line of Credit - Commercial 6200 31 29 $2,313,875 $74,641 4.41 9.7 /(24) ($5,718) Business Participation- Sold L123 2 1 $1,471,625 $735,813 2.61 11.2 /(2) ($31,699) BUSINESSVR LOC L68 7 6 $445,442 $63,635 7.79 19.1 /(3) ($3,303) BUSINESSLOAN LOC-FIXED L77 15 15 $80,706 $5,380 10.2 7.1 /(13) ($4,320) BUSINESSLOAN FCL L83 5 5 $257,775 $51,555 6.61 2.8 /(5) ($3,538) BUS LOAN HE LOC L88 2 2 $58,326 $29,163 6.00 5.3 /(1) ($4,124)
  38. 38. Pricing profitability – business loans • Problem – Portfolio size – Capacity – Overhead • Solution – Reallocate workforce – Grow/purchase portfolio
  39. 39. Profitability review - auto Loan Product Code Number of Accounts Number of Relationships Total Balances Average Balance Per Account Weighted Average Rate Weighted Avg. Maturity in Months Annualized Average Profit Per Account Auto & Rec Vehicles Loans 2,853 2,484 $38,009,822 $13,323 5.81 51.8/ (2,819) $68 New Auto Loan Direct 7010 321 310 $6,697,081 $20,863 4.82 59.5 /(321) $134 NEW VEHICLE A+ L1 154 150 $2,852,702 $18,524 2.97 52.7 /(0(1)54) ($81) NEW VEHICLE A L2 43 43 $950,290 $22,100 3.99 66.7 /(0(4)3) $59 NEW VEHICLE B+ L3 31 29 $741,352 $23,915 4.97 63.3 /(0(3)1) $194 NEW VEHICLE B L4 46 46 $1,088,848 $23,671 6.22 61.8 /(0(4)6) $350 NEW VEHICLE C L5 29 29 $650,693 $22,438 7.62 66.8 /(0(2)9) $511 NEW VEHICLE D L6 18 18 $413,196 $22,955 11.2 65.7 /(0(1)8) $895 Used Auto Loan Direct 7012 2,532 2,235 $31,312,741 $12,367 6.02 50.2 /(2,498) USED VEHICLE A+ L11 746 695 $10,559,605 $14,155 3.64 50.7 /(0(7)45) ($52) USED VEHICLE A L12 397 378 $5,432,760 $13,685 4.43 51.6 /(0(3)95) $17 USED VEHICLE B+ L13 239 227 $3,186,054 $13,331 5.25 53.8 /(0(2)38) $55 USED VEHICLE B L14 435 411 $5,354,302 $12,309 6.52 50.5 /(0(4)28) $88 USED VEHICLE C L15 291 280 $5,354,302 $10,954 9.08 47.8 /(0(2)80) $146 USED VEHICLE D L16 331 303 $3,062,439 $9,252 12.96 46.2 /(0(3)20) $231 NEXT AUTO LOAN L17 93 92 $530,013 $5,699 11.17 37.9 /(0(9)2) $127
  40. 40. Pricing profitability – auto • Happy with results – part of game plan • “A paper” is relationship pricing • Don’t be afraid to ask why • Most customers are unprofitable
  41. 41. Summary
  42. 42. Banking culture • Wait for growth to walk through the door Banking hours • Drive growth by sell and cross – selling anything to everyone who comes through the door Sales culture • Maximize profitable growth by selling and up-selling profitable products and target the correct markets Profitability
  43. 43. Profit risk – institution profit vs. top 10% profit 5.6 26.2 6.9 33.0 7.7 38.0 2016 2016 2017 2017 2018 2018 Profit Risk InMillions($)
  44. 44. Net income stagnation Non interest income $19.8M (Dec 2018) Non interest expense $42.8M (Dec 2018) Net interest margin $36.2M (Dec 2018) Net income $13.2M (Dec 2018) Net interest margin $31.7M (Dec 2017) Non interest income $18.6M (Dec 2017) Non interest expense $37.5M (Dec 2017) Net income $12.8M (Dec 2017)
  45. 45. Profitability – service Product/Service​ Number of Accounts​ Total Profitability​ Concentration​ Mortgages​ 1,592​ $1,966,884 89% Home Equity Loans/Lines​ 1,889​ $937,630 42% Money Market​ 1,476​ $780,341 35% Interest Checking​ 2,787​ $624,687 28% Business Loans​ 354​ $502,561 23% Auto Loans​ 4,629​ $435,138 20% Business Checking​ 1,678​ $181,216 8% Retirement​ 2,462​ $64,023 3% Investments/Insurance​ 2,042​ -$61,919 -3% Certificates of Deposit​ 5,796​ -$196,668 -9% Credit Cards​ 3,278​ -$405,223 -18% Electronic Services​ 23,524​ -$616,835 -28% Free Checking​ 15,894​ -$949,738 -43% Savings​ 11,590​ -$1,051,058 -48% Total​ 78,991​ $2,211,039 100%
  46. 46. Building the database Systems of record General ledger BH Analytics Service Branch Region Institution Individual Relationship (household) Customer/ member Product group Product Allocation rules Account level
  47. 47. Questions? Jeff.Dwornicki@bakerhill.com

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