PERFORMANCE MEASUREMENT/PROFITABILITY ANALYSIS

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Financial Managers SocietyNew York-New Jersey
ChapterAll Day SeminarSeptember 14, 2005

• PERFORMANCE MEASUREMENT/PROFITABILITY ANALYSIS
• Organizational/Branch/Line-of-Business/Product/Cus
  tomer/Relationship/Market Segment
• Funds Transfer Pricing/Cost-Capital Assignment
• Robert E. Kafafian, President C.E.O.
• Office - [phone] Ext. 106 Fax (973)
  299-1002
• RKafafian_at_KafafianGroup.com
• www.KafafianGroup.com

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Alvin Toffler-Author FUTURE SHOCK, THE THIRD
SHIFT, POWER SHIFT

• Bankers have been saying for years that they are
  in the information business .......... but they
  fail to realize how deeply they are in an
  information business. Bankers also over rate
  their ability to use information.

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Robert Slater, Editor BANKERS MONTHLY

• In the business world those that have
  information will prosper. Those that dont will
  face great obstacles in achieving their goals.
  Nowhere is this more true then in the banking
  industry. Ironically, much of the information
  banks need to compete effectively is already in
  their possession. The trick is learning how to
  compile it and use it successfully.

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Jim McCormick, President First Manhattan Consultin
g Group

• A profitability reporting system that shows
  risk-adjusted return on equity by business unit
  is essential. Banks should use such management
  information systems in strategic planning,
  budgeting, risk management, performance
  measurement, and incentive compensation. The
  best banks, with useful MIS and disciplined
  management processes are moving away from the
  pack ........ this is no longer optional .

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Richard Bove, Banking Analyst Punk Ziegel Co.,
LP

• MAKE YOUR BANK EASY FOR WALL STREET TO UNDERSTAND
• Specifically, this means each bank must
• Define the markets into which it sells products
• Define the products sold
• Indicate the profitability of product lines
• If investors do not get such information, they
  will continue to see banks as undefined packages
  of assets. As a result, bank stocks will not
  attain high multiples. The prices will reflect
  investors feeling that they cannot reliably
  predict banks rates of return.

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• EIGHT FUNDAMENTAL MOVEMENTS
• De-Regulation/Re-Regulation
• Asset Liability Management
• Performance Measurement
• Product Diversification
• Service/Sales Culture
• Risk Management
• Industry Consolidation/Convergence
• Technology-Information Management

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• 1. DE-REGULATION/RE-REGULATION
• Product/Rate
• Industry Mix
• CRA/Privacy
• Gramm-Leach-Bliley Act/ Financial
  Modernization Act
• Sarbanes/Oxley
• Money Laundering/USA Patriot Act
• Cross Industry/Regulatory Control

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• 2. ASSET LIABILITY MANAGEMENT
• Balance Sheet Management
• GAP Management
• Interest-Rate Risk
• Focus on remaining maturity
• Front-end to Budget/ Planning Process
• Limited slicing of data
• Limited NIE analysis
• Usually presented at a high-level

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• 3. PROFITABILITY ANALYSIS
• More detailed analysis of various organizational
  components and slices
• More detailed expense analysis and breakdown to
  the bottom-line
• Organizational/Product/Customer
• Relationship/Market Segment
• Focus on original maturity
• Rank/Compare/Trend
• Usable throughout all
• areas of the organization

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• 4. PRODUCT DIVERSIFICATION
• Loan Deposit
• Fee-Based
• Trust
• Brokerage
• Insurance
• Delivery Channels
• Internet Banking
• Sales Culture (Trusted Advisor Culture)

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• 5. SERVICE/SALES CULTURE
• Cross-Selling
• Products Per Customer
• Service Opportunities
• Sales Opportunities
• Incentives/Disincentives
• Service/Sales Training
• Service/Sales Tools

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• 6. RISK MANAGEMENT
• Traditional Risk
• Credit-Oriented
• Current View of Risk
• Risk-Adjusted Return
• on Capital (RAROC)
• Types of Risk

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• 7. INDUSTRY CONSOLIDATION/ CONVERGENCE
• Financial Services
• Mortgage
• Credit Card
• Brokerage
• Insurance
• Communications
• Technology

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• 8. TECHNOLOGY-INFORMATION MANAGEMENT
• Encompasses the Other Six Movements
• Technology Lag
• Sourcing Opportunities
• Information Systems
• Accounting/Marketing/IT
• Delivery Channels
• The Internet

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• Keys to Profitability Survival Success
• Marketing effort or study to determine what
  products and services do our customers want,
  through what delivery channels
• Internal analysis to determine what products and
  services do we sell that they want in what
  combination of delivery channels
• ..AT A PROFIT

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• PREREQUISITES TO MEANINGFUL
• MANAGEMENT INFORMATION
• Senior managements support
• Reflect managements operating philosophy
• Provide management information, not just
  regulatory information
• Understandable to the end-user
• Consistently applied
• Provide value as well as benefit

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• MANAGEMENT INFORMATION
• 1. Asset Liability Management
• 2. Budget and Planning Process
• 3. Responsibility Reporting
• PROFITABILITY ANALYSIS
• 4. Organizational Profitability Reporting
• 5. Product Profitability Reporting
• 6. Branch Profitability Reporting
• 7. Customer/Relationship Profitability
  Reporting
• 8. Market Segment Profitability Reporting
• 9. Opportunity Profitability Reporting
• SUPPORT FUNCTIONS
• 10. Funds Transfer Pricing
• 11. Cost-Capital Assignment/ABC/Performance
  Measurement
• 12. Data Warehousing/Mining/Mapping/MCIF/CRM

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• REPORTING CONSIDERATIONS
• Reconcilable
• Audit Trails
• Ranking Reports
• Comparative Reports
• Trend Reports
• Summary and Detailed Levels
• Macro versus Micro Approach
• Rate/Volume Analysis
• ROA/ROE, Efficiency, Risk Based Capital, etc.
• Peer Group Analysis

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• LINE-OF-BUSINESS PROFITABILITY
• Similar and or part of responsibility reporting
• Organization structure - hierarchy table
• Part of, or roll-up of all other profitability
• Financial information about profit centers
• Assessing performance of groups of staff engaged
  in profit-producing activity

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• TYPES OF PRODUCTS
• Fund Providing
• Demand Deposits
• Savings Deposits
• Time Deposits
• Other Borrowings
• Fund Using
• Investments
• Short-Term Assets
• Loans
• Non-Fund/Fee-Based
• Safe Deposit Boxes
• Mortgage Servicing
• Trust, Insurance, Brokerage, etc.

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• FUND PROVIDING PRODUCTS
• Fund Providing Products (FPP) are primarily an
  accumulation of fund sources or deposits.
  Branches typically generate the majority of
  deposit products, however, borrowed funds, or
  purchased or brokered deposits, are also sources
  of funds available to banks.

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• EX FUND PROVIDING PRODUCTS
• Regular Savings Time Deposits
• Statement Savings 0-3 Months
• Money Market 6-12 Months
• IRA Accounts 1-2 Years
• Club Accounts 2-5 Years
• DDA-Individual 5 Years
• DDA-Business CDs 100,000
• Now Accounts Public Funds
• FF-Purchased Other Borrowings

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• FUND USING PRODUCTS
• Fund Using Products (FUP) are primarily earning
  assets, normally consisting of loans or
  investments typically found in a special purpose
  revenue center, and often consisting of several
  homogeneous products.

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• EX FUND USING PRODUCTS
• Liquidity Portfolio Commercial-Fixed
• Investment Portfolio Commercial-Floating
• Fed Funds Sold Commercial-Adjustable
• Mtg-Adjustable Commercial-SBA
• Mtg-Fixed Home Equity
• Mtg-Commercial Second Mortgages
• Consumer-Auto Overdrafts
• Consumer-Personal
• Consumer-Floor Plan

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• NON-FUND/FEE-BASED PRODUCTS
• Non-Fund Products (NFP) generally have only
  incidental balances. The sole source of revenue
  for these products is typically fees for
  services.

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• EX NON-FUND/FEE-BASED PRODUCTS
• Trust Services Safe Deposit Boxes
• ATM Services Brokerage Services
• Secondary Market Mortgage Servicing
• Travelers Checks Series E Bonds
• Checkbook Services Insurance Services

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• CUSTOMER PROFITABILITY
• Account Level Profitability
• Individual Relationship Profitability
• Extended Relationship Profitability
• Market Segment Profitability

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• MARKET SEGMENT PROFITABILITY
• WWII Generation (65 and Over)
• Swing Generation (56-64)
• Baby Boomers (33-55)
• Generation X (19-32)
• Baby Boomlets (Under 19)
• Other Categories (Empty Nesters, DINKS, etc.)

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• MCIF-MARKERTING CUSTOMER INFORMATION FILE
• Connectivity of Data
• Matching Markets/Products/Sales/Service
• Market Demographics

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• CRM-CUSTOMER RELATIONSHIP MANAGEMENT
• Contact Information
• Sales and Service Tracking
• Performance Measures

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• MINING AND MAPPING DATA
• Where are the opportunities?
• Where should the focus be?
• Geographic
• Customer type
• Advertising/marketing/promotion/sales and service

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• PROFITABILITY EMPHASIS
• CMTY
• BKS MEL
• Fund Using/
• Fund Providing
• 83 Products 31/15
• - - - - - - - - - - - - - -
• Interest Income/
• Interest Expense
• Non-Fund Products
• 17 - - - - - - - - - - - - - -
  69/85
• Non-Interest Income

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• FUNDS TRANSFER PRICING
• Single Rate/Pool
• Specific Matching
• Multiple Pool Matching - Actual Cost of Funds
• Matched Maturity Coterminous

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Asset Spread
Total Interest Spread
Treasury Spread
Liability Spread
Data Warehouse/ Funds Transfer
Pricing
General Ledger
Other Databases
Loans Deposits Securities
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• Cost Basis CQTR LQTR DIFF
• Interest Income 7.81 7.75 0.06
• Interest Expense 3.45 3.43 0.02
• Net Spread 4.36 4.32 0.04

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• Market Basis CQTR LQTR DIFF
• Fund Using
• Interest Income 7.81 7.75 0.06
• FTP-Charge 6.25 6.15 0.10
• Spread 1.56 1.60 (0.04)
• Fund Providing
• FTP-Credit 6.11 6.07 0.04
• Interest Expense 3.45 3.43 0.02
• Spread 2.66 2.64 0.02
• Maturity Gap 0.14 0.08 0.06
• Net Spread 4.36 4.32 0.04

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• Cost Basis CQTR LQTR DIFF
• Interest Income 7.81 7.75 0.06
• Interest Expense 3 45 3.43 0.02
• Net Spread 4.36 4.32 0.04
• Market Basis CQTR LQTR DIFF
• Fund Using
• Interest Income 7.81 7.75 0.06
• FTP-Charge 6 25 6.15 0.10
• Spread 1.56 1.60 (0.04)
• Fund Providing
• FTP-Credit 6.11 6.07 0.04
• Interest Expense 3.45 3.43 0.02
• Spread 2.66 2.64 0.02
• Maturity Gap 0.14 0.08 0.06

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• TRANSFER PRICING-
• PRODUCT CHARACTERISTICS
• Original Maturity
• Stated Maturity
• Stated Repricing
• Duration
• Cash Flow
• Blended Rate

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• CURVES
• Treasury
• FHLB
• Swap
• LIBOR
• Build
• Other
• Supplemental Margins

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• SUPPLEMENTAL MARGINS
• Incremental Margins
• Market Risk
• Credit Risk
• Risk Based-Capital
• Prepayment Penalties
• Early Withdrawal Penalties
• Other

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• HIGHLIGHTS OF MATCHED MATURITY
• Places focus on original maturity, duration,
  cash-flow, or blended rate
• Levels playing field by consistently pricing to
  market driven indices
• Isolates fund using, fund providing, and treasury
  responsibility and contribution
• Induces managers to make incremental decisions
• Forces managers to actively manage interest
  spread
• Enables management to assess true profitability
  for each product and line-of-business
• Illustrates effects of changes in product mix
  within lines-of-business
• Identifies negative and positive trends, problems
  and opportunities
• Permits easier comparisons to industry/peer
  groups

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Marginal Contribution CDs One
Year Maturity
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Marginal Contribution CDs One Year Maturity
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Marginal Contribution CDs One Year
Maturity
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Marginal Contribution CDs One Year
Maturity
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• PERFORMANCE MEASUREMENT-
• COST/CAPITAL ASSIGNMENT
• Activity-based-costing
• Full absorption versus standard costing
• Variable/fixed-direct/indirect costs
• Isolating efficiencies/inefficiencies
• Capacity utilization
• Allocations methodologies
• Average balances
• Fixed percentages
• Statistical databases
• Regulatory/Risk-Based Capital
• Internally developed capital assignment (RAROC)

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E I S


Organization Profitability
Ad - Hoc Profitability
Product Profitability
Customer Profitability
Opportunity Profitability
ALM
MCIF
Data Warehouse/ FTP
Funds Transfer Pricing
Cost Allocation
Interface Engine
General Ledger
Other Databases
Loans/Deposits/Securities
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• OVERALL OBJECTIVES OF MIS
• Assist in strategic decision making and the
  budget process
• Provide information to manage GAP, Organizational
  Units, Products, Branches, Customers,
  Relationships, Market Segments, Exposures, etc.
• Assist in the measurement of performance (i.e.,
  units/people)
• Assist in the determining of performance rewards,
  i.e. compensation, bonuses, incentives
• Provide the detail to understand and evaluate
  complex issues and problems
• Remembering the 80/20 rule ..... Get enough
  information to be accurate ..... not all
  inclusive information, which can cause needless
  complexity and sometimes misleading results

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• MEASURING AND ACHIEVING SUCCESS
• Develop meaningful management information to make
  more informed decisions and manage riski.e., the
  users use the system
• Productivity will be increased
• Performance should be rewarded
• The Bottom-Line is improved
• All constituencies are satisfied

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Financial Managers SocietyNew York-New Jersey
ChapterAll Day SeminarSeptember 14, 2005

• PERFORMANCE MEASUREMENT/PROFITABILITY ANALYSIS
• Organizational/Branch/Line-of-Business/Product/Cus
  tomer/Relationship/Market Segment
• Funds Transfer Pricing/Cost-Capital Assignment
• Robert E. Kafafian, President C.E.O.
• Office - [phone] Ext. 106 Fax (973)
  299-1002
• RKafafian_at_KafafianGroup.com
• www.KafafianGroup.com