1. Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation
Skiera, 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),

2. Paper in Journal of Marketing
Skiera, 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),
© 2011, American Marketing Association

3. Aim and Contribution of Our Research
Customer equity should play a more prominent role in financial reporting
The 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
Emphasize the importance of reporting forward-looking metrics
Propose customer equity reporting (CER) and the customer equity sustainability ratio (CESR) as potential means to increase transparency in financial statements
Provide stakeholders with valuable information about the long-term value of a customer base
Argue that more forward-looking metrics might have diminished the devastating consequences of the current financial crisis 3

4. Securitization in Non-Financial Businesses (1/2)
Soccer club realizes earnings from ticket sales
soccer club fans
soccer entertainment
earnings from ticket sales
$100,000,000
soccer club
5 years considered; 20 games per year; 50,000 spectators per game; $20 per ticket
Total earnings of the soccer club from ticket sales: $100,000,000 ($20,000,000 each year) 4

5. Securitization in Non-Financial Businesses (2/2)
Soccer club transfers its future ticket sales to a bank
soccer club
soccer entertainment
$75,815,735
one-time earnings from securitization
soccer club fans
bank
earnings from ticket sales over next five years
$100,000,000
Discount rate: 10%
Discounted net present value of total earnings: $75,815,735 5

6. European Union’s Trouble with Greece
Banks 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

7. Securitization in Financial and Non-Financial Industries
Securitization in the financial industry: Underlying products
Securitization in non-financial industries: Underlying products
Mortgages
Future telecommunications usage
Car financing
Future electricity consumption
Consumer loans
Future tax assets
Student loans
Future health care receivables
Credit cards
Future royalties of intellectual properties
Leasing claims
Ticket securitization - Airlines
- Railway
- Sport events
- Cultural events
- Museums
- Fairs and Exhibitions
- etc.
Commercial loans
Commercial papers
Insurance premiums
(e.g., Bermes 2011; Bessler 2007; Jobst 2002) 7

8. Basic Idea of Securitization in Banking (1/2)
Traditional banking business is to borrow and lend money (buy and hold)
t0: loans
t1 to tn: interest
and amortization
loan borrowers
bank
loan granter
Non-securitization
Loans (mortgages, business financing, consumer loans etc.) are offered mainly to bank’s own customers
Amortization can be paid e.g. annually or at the end of the contract period (bullet loan) depending on the loan structure
Interest is paid by borrowers constantly (often monthly or annually) on loan volume outstanding
Banks earn money from the margin between the interest rate of the loan and the refinancing costs minus provisions for expected loan losses
Banks receive the interest margin constantly over the lifetime of the loan contract (for bullet loans) 8

9. Basic Idea of Securitization in Banking (2/2)
Traditional banking business is extended to securitization (originate and distribute)
loan borrowers
t1 to tn: interest
and amortization
trustee
t0: loans
t0: loan claims
SPV
t0: price for
loan claims
securities
t0: securities
investors
bank
loan granter
Securitization
Loans are sold to special purpose vehicles (SPV) and therewith handled outside the bank’s balance sheet
Loans are packed and structured into investment tranches with different underlying risk levels
Tranches are distributed to investors
A trustee collects interest and amortization cash flows from borrowers and redirects them to investors
Investors face the risk of loan defaults 9

10. Underestimated Risk in Securitized Assets
“First round“ collateralized debt obligations (CDO)
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
Securitization
“Second round” collateralized debt obligations (CDO2)
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
CDO with different tranches
Senior tranche (AAA to A)
Mezzanine tranche (BBB to B)
Junior tranche (without any rating)
Equity tranche (residuum)
Securitization 10

11. Previous Research on Securitization in Finance
Credit and market risk
Liquidity risk and funding
Through securitization, ...
Banks can manage credit and market risks of the underlying loan portfolios
E.g.:
Ambrose, Lacour-Little, and Sanders (2005)
Coval, Jurek, and Stafford (2009)
Franke and Krahnen (2008)
Lockwood, Rutherford, and Herrera (1996)
Luo, Tang, and Wang (2008)
Purnanandam (2009)
Through securitization, ...
Banks can reach stronger liquidity positions
Banks can easier fulfill regulatory requirements such as Basel II/III
E.g.:
Ambrose, Lacour-Little, and Sanders (2005)
Calem and LaCour-Little (2004)
Jones (2000)
Purnanandam (2009)
Twinn (1994)

12. Banking Example: Assumptions and Calculation Basis
We distinguish between a non-securitizing and a securitizing bank
The banks each issue a five-year loan volume of $100,000 to customers at the beginning of each year
The annual net interest margin of the loans is 1% (5% interest rate; 3.5% refinancing expenses; 0.5% loan loss provisions)
No other deductions or costs occur
Discount rate is 10%
The non-securitizing bank gets the interest income at the end of each year
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
Customer equity is valued as of the end of each year
Equity is $30,000
We analyze two cases:
Distribution case: The banks pay out all of their earnings as dividends at the end of each year
Reinvestment case: The banks reinvest the earnings at a return rate of 10% 12

13. Banking Example: Non-Securitizing Bank13

14. Banking Example: Securitizing Bank14

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

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

17. Customer Metrics to Increase Transparency in Financial Reports
CER and CESR provide comprehensive transparency information
Customer Equity Reporting (CER)
CER provides stakeholders with valuable information about the long-term value of a bank’s current customer base (Wiesel, Skiera, and Villanueva 2008)
CER publishes detailed customer structures with related earnings and costs in absolute numbers
CER can issue a forward-looking statement
Newly developed Customer Equity Sustainability Ratio (CESR)
CESR compares the likely future earnings of the existing customers to current earnings
CESR identifies shifts in value realizations over time
CESR reports the sustainability of the bank’s earnings as a relative number in a simple and substantial way 17

18. Customer Equity Sustainability Ratio (CESR)
CESR is a new metric to quantify the intensity of long-term value creation
Defining CESRj as 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:
(2)
(3) 18

19. Relationship Between Customer Equity (CE) and Customer Equity Sustainability Ratio (CESR)
Short-Term Profit Realization with a Strong Customer Base
Long-Term Value Creation with a Strong Customer Base
Short-Term Profit Realization with a Weak Customer Base
Long-Term Value Creation with a Weak Customer Base
CE (high)
CE (low)
CESR (low)
CESR (high)

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

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

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

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

24. Empirical Study of Countrywide: General Information
Countrywide was the market leader in mortgage banking
Countrywide Financial Corporation (CFC) was the U.S. market leader in mortgage lending and origination between 2004 and 2007
Countrywide provides a detailed view of the shift from long-term value creation to short-term profit realization
Countrywide was heavily engaged in subprime mortgage-backed securities (MBS) transactions
Countrywide needed a rescue from Bank of America in February 2008
As a subsidiary of Bank of America, Countrywide no longer publishes its own financial statements, so our analysis comprises 24

25. Empirical Study of Countrywide: Securitization of Mortgage Loans4
Empirical Study of Countrywide: Securitization of Mortgage Loans
Total Mortgage Loans Volume (in m USD)
92,881
66,740
68,923
123,969
251,901
434,864
363,364
499,301
468,172
415,634 5% 4%
95%
96%
86%
89%
90%
86%
82%
72%
65%
59%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
% of Volume of Mortgage Loans Hold
% of Volume of Mortgage Loans Sold 25

26. Empirical Study of Countrywide: Earnings Structure26

27. Empirical Counterfactual Analysis of Countrywide: Total Earnings27

28. Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings28

29. Empirical Counterfactual Analysis of Countrywide: Customer Equity29

30. Empirical Counterfactual Analysis of Countrywide: CESR
0.673
Factor 3.2
0.210 30

31. Empirical Counterfactual Analysis of Countrywide: Factors in CESR31

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

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

34. Discussion and Conclusion
CER and CESR provide valuable information for the firm’s stakeholders
Customer equity reporting (CER) and the customer equity sustainability ratio (CESR) are feasible in a real-world setting
CER and CESR as forward-looking customer metrics provide stakeholders with transparency about the long-term value of a firm’s current customer base
CESR can better identify shifts in value realizations over time
CESR reports the sustainability of the firm’s earnings in a simple and substantial way
CER and CESR provide insights into how investors and firms can be supported to avoid some of the challenges of a future financial crisis 34

35. Need more Information? Contact one of us!
Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation
Need more Information? Contact one of us!
Contact:
Prof. Dr. Bernd Skiera
Manuel Bermes
Lutz Horn
Goethe University Frankfurt
House of Finance
E-Finance Lab
Retail Banking Competence Center
Grueneburgplatz 1
60323 Frankfurt am Main 35 35