The document introduces the Customer Equity Sustainability Ratio (CESR) as a new metric for assessing a firm's long-term customer value and future orientation in financial reporting. It emphasizes the need for forward-looking metrics like Customer Equity Reporting (CER) and CESR to enhance transparency and help stakeholders evaluate the sustainability of earnings. The research outlines how these metrics can mitigate the focus on short-term profits and provide insights into potential financial crises.

1. Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future OrientationSkiera, 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 Marketing2Skiera, 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 ResearchCustomer equity should play a more prominent role in financial reportingThe 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 crisis3

8. Securitization in Non-Financial Businesses (1/2)Soccer club realizes earnings from ticket salessoccer entertainmentearnings from ticket sales$100,000,000soccer clubsoccer club fans5 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 banksoccer entertainmentone-time earnings from securitization$75,815,735soccer clubearnings from ticket sales over next five yearssoccer club fansbank$100,000,000Discount rate: 10%

11. Discounted net present value of total earnings: $75,815,7355

12. European Union’s Trouble with Greece 6Banks 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)bankloan grantert0: loansNon-securitizationLoans (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: interestand amortizationloan borrowers8

19. Basic Idea of Securitization in Banking (2/2)Traditional banking business is extended to securitization (originate and distribute)SPVinvestorsbankloan grantertrusteet0: price forloan claimst0: loanst0: price forsecuritiest0: loan claimst0: loan claimst0: securitiesSecuritizationLoans 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 defaultst1 to tn: interestand amortizationt1 to tn: interestand amortizationloan borrowers9

24. Underestimated Risk in Securitized Assets“First round“ collateralized debt obligations (CDO)Securitization“Second round” collateralized debt obligations (CDO2)Securitization10

25. Previous Research on Securitization in Finance11Credit and market riskLiquidity risk and fundingThrough securitization, ...Banks can manage credit and market risks of the underlying loan portfoliosE.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/IIIE.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 BasisWe 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 Bank13

48. 14Banking Example: Securitizing Bank

49. 15Banking Example: Effects of Securitization on Earnings (Distribution Case)

50. 16Banking Example: Effects of Securitization on Return on Equity (Distribution Case)

51. Customer Metrics to Increase Transparency in Financial ReportsCER and CESR provide comprehensive transparency informationCER 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 statementCustomer 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 way17

56. Customer Equity Sustainability Ratio (CESR)CESR is a new metric to quantify the intensity of long-term value creationDefining 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)19CE (high)Short-TermProfit Realizationwith a StrongCustomer BaseLong-TermValue Creationwith a StrongCustomer BaseCESR (low)CESR (high)Short-TermProfit Realizationwith a WeakCustomer BaseLong-TermValue Creationwith a WeakCustomer BaseCE (low)

58. 20Banking Example Revisited: Effects of Securitization on CE (Distribution Case)

59. 21Banking Example Revisited: Effects of Securitization on CESR (Distribution Case)

60. 22Empirical Study About Transparency of Securitization in Banks’ Financial Reports (1/2)

61. 23Empirical Study About Transparency of Securitization in Banks’ Financial Reports (2/2)

62. Empirical Study of Countrywide:General InformationCountrywide was the market leader in mortgage bankingCountrywide 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 1998-200724

67. 4Empirical Study of Countrywide:Securitization of Mortgage LoansTotal Mortgage Loans Volume (in m USD)468,172499,301123,96968,923415,63466,74092,881363,364434,864251,9014%5%96%95%90%89%86%86%82%72%65%59%2005200120062000199920071998200420032002% of Volume of Mortgage Loans Hold% of Volume of Mortgage Loans Sold25

68. Empirical Study of Countrywide:Earnings Structure26

69. 27Empirical Counterfactual Analysis of Countrywide: Total Earnings

70. 28Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings

71. 29Empirical Counterfactual Analysis of Countrywide: Customer Equity

72. Empirical Counterfactual Analysis of Countrywide: CESR0.673Factor 3.20.21030

73. 31Empirical Counterfactual Analysis of Countrywide: Factors in CESR

74. 32Securitization in Industries Outside Banking (1/2)

75. 33Securitization in Industries Outside Banking (2/2)

76. Discussion and ConclusionCER and CESR provide valuable information for the firm’s stakeholdersCustomer 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 crisis34

81. Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future OrientationNeed more Information? Contact one of us!35