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Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer.

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Presentation on theme: "Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation Skiera, Bernd / Bermes, Manuel / Horn, Lutz (2011), "Customer."— Presentation transcript:

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 Bank
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14 Banking Example: Securitizing Bank
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15 Banking Example: Effects of Securitization on Earnings (Distribution Case)
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16 Banking Example: Effects of Securitization on Return on Equity (Distribution Case)
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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)
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21 Banking Example Revisited: Effects of Securitization on CESR (Distribution Case)
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22 Empirical Study About Transparency of Securitization in Banks’ Financial Reports (1/2)
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23 Empirical Study About Transparency of Securitization in Banks’ Financial Reports (2/2)
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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 Loans
4 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 Structure
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27 Empirical Counterfactual Analysis of Countrywide: Total Earnings
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28 Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings
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29 Empirical Counterfactual Analysis of Countrywide: Customer Equity
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30 Empirical Counterfactual Analysis of Countrywide: CESR
0.673 Factor 3.2 0.210 30

31 Empirical Counterfactual Analysis of Countrywide: Factors in CESR
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32 Securitization in Industries Outside Banking (1/2)
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33 Securitization in Industries Outside Banking (2/2)
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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


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