This document discusses relationship profitability and key performance indicators for financial institutions. It covers topics like interest rates, costs, margins, returns on assets and equity. Critical measures for evaluating profitability are gross margin, net interest margin and net income. Key performance indicators discussed include return on assets, return on equity, and risk-adjusted return on capital. The document also discusses funds transfer pricing, deposit trends, and challenges from new fintech competitors in engaging millennial customers.

1. John Robertson – Senior Business Process Architect
Relationship Profitability Is Back!

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. 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. Critical indicators
• Return on assets (ROA)
• Return on equity (ROE)
• Risk-adjusted return on
capital (RAROC)

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. 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. 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. 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. Deposits value
added

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. 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. FTP rate trends

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. 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. 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. Relationship
profitability

17. Reasons banks use relationship profitability
• Margin compression
• Relationship management
• Risk management
• Performance measurement
• Return on shareholders equity
• Measurement consistency
• Business and marketing strategy

23. Deposits:
breakdowns
and trends

24. 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

25. Loans to deposits %—past 7 years

26. Interest expense mix—past 10 years

27. Analytics can
identify your
potential
exposure

28. 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?

29. Ask yourself

30. 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

34. Immediate insights

35. New
competitors for
the millennial’s
money:
fintechs

36. 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

37. The millennials—who are they?

38. 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

39. 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

40. 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.”

41. Avoid being a commodity
93 YEARS TO BUILD
610,000 ROOMS, 88 COUNTRIES
4 YEARS TO AMASS
650,000 ROOMS, 192 COUNTRIES

42. Replaced value: tech & convenience
$23
Billion Market
Capitalization
$31
Billion Venture
Capital Funding

43. FinTech disruptors

44. In the news…

45. Disrupting within the bank

46. 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

47. 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

48. Questions?

49. Thank you!
John.Robertson@bakerhill.com