FIVE CRITICAL ASPECTS OF PROFITABILITY ANALYSIS · PDF fileAio oftares nifie Perforance...

FIVE CRITICAL ASPECTS OF PROFITABILITY ANALYSISA GUIDE FOR FINANCIAL INSTITUTIONS

Five Critical Aspects of Profitability Analysis2 © Copyright 2016 by Kaufman, Hall & Associates, LLC

As it ost b sinesses profitability is one of t e ost critical perfor ance etrics for s ort ter an

lon ter financial ealt of financial instit tions

Benefits of a robust profitability framework:

• elps n erstan t e tr e rivers of cost an profitability in t e instit tion

• eveals ic parts of o r instit tion enerate c sto er val e

• o s ic pro cts an c sto ers are profitable an ic ero e val e

• entifies t e tr e cost of provi in s pport services

• Assists in analy in o s are services are bein cons e

ntro ctiony nstit tions o l eas re Profitability


• Funds Transfer Pricing t e process of c ar in f n sers an cre itin f n provi ers by allocatin t e net interest ar in to eac acco nt on t e balance s eet

• Service Transfer Pricing t e process of allocatin centrali e costs to profit centers base on cons ption or se allocates an instit tion s non acco nt specific inco e an e penses to t e vario s i ensions of profitability

• Capital Allocation t e process of allocatin capital to allo eas re ent on a ris ret rn basis assi ns capital base on t e

ris profile of an instr ent or portfolio alon it t e c sto er an acco nt type for a ret rn on capital calc lation

• Multi-dimensional Reporting t e ability to e ibly slice an ice infor ation allo s an instit tion to better n erstan its overall profitability by nitin t e o tp ts of t e above processes in a sin le

lti i ensional repository

ey Co ponents of Profitability Fra e or


Critical Aspects of Profitability Analysis

F n s ransfer Pricin

Determine i ensionality

C oose t e i t Approac

on nterest nco e an pense Allocations

1 3 42

e follo in five aspects of profitability analysis are critical to creatin an s stainin a profitability eas re ent pro ra t at can be se to rive ecisions an i prove financial perfor ance

Assi n ent of t e oan oss Provision

an is base Capital

5


F n s ransfer Pricin

F n s ransfer Pricin F P is t e process of c ar in f n sers an cre itin f n provi ers by allocatin t e net interest ar in to eac acco nt on t e balance s eet

Goal of FTP - Acc rately an rationally eas re t e cost or cre it of f n s in s pport of

• Profitability eas re ent

• ar in eas re ent

• Pro ct Pricin

• ecentrali e ecision a in

F P allo s or ani ations to ans er estions incl in

• ic loan pro cts are profitable

• ic branc es are losin oney

• o eposits contrib te to profits

• ic c sto ers are profitable

Funds Transfer Pricing1


Determine Dimensionality

eter ine i ensionality

eter ine t e i ensionality yo nee by t in in abo t o yo ant to loo at profitability ata so yo can ta e action to i prove profitability Consi er loo in at a cross section of i ensions rat er t an eac one in ivi ally

Consider these key dimensions for analysis:

• r ani ation ranc es ines of siness e ions ar ets

• Pro cts Pro ct ines n les

• C sto ers o se ol s e ents iers eciles

• C annels eb A ric an ortar

• cers

2


r ani ational profitability

• val ate contrib tion of nits incl in all costs bot irect an in irect

• eveal nits t at brin t e ost profit to t e or ani ation

• eter ine t e cons ers of s are services

• ana e reso rces ore e ectively ile aintainin or i provin services

Determine Dimensionality2


Pro ct profitability

• val ate contrib tion of pro cts incl in all costs bot irect an in irect

• eveal pro cts t at brin t e ost profit to t e or ani ation

• Analy e tren s in pro ct profitability relate to vol es sales an i

• Analy e fi e vs variable cost i


MTD Product Rankings as of 11/30/11 (Ranked by Net Contribution Margin)


C sto er profitability• Analy e rivers be in c sto er profitability

• an top an botto contrib tors

• e ent c sto er portfolio for eeper analysis

• val ate cost benefit of pro otions


Top 10 Contribution9,000,0008,000,0007,000,0006,000,0005,000,0004,000,0003,000,0002,000,0001,000,000

0Customers Officers

Top 10 Remainder


op o n approac

r ani ations typically ta e eit er a top o n or botto s p approac to profitability analysis A top o n approac is typically a eneral le er centric approac ile a botto s p approac typically involves an instr ent level foc s elo is a top o n approac

Provide Unit Costs

Pr

General Ledger

OrganizationalProfitability

Allocate Costs to Profit Centers

ProductProfitability

Allocate Costs to Products

LoanSystems

DepositSystems

Fee BasedSystems

Transactional Data

Customer Profitability

• Different Methodologies between systems

• Multiple Reconciliations

Choose the Right Approach3


otto s p approac

LoanSystems

DepositSystems

Fee BasedSystems

Transactional Data

Customer Profitability

Transactional Data

Rollup to Other Dimensions

Product Org Channel Officer

General Ledger

Serves as a Point of Reconciliation and a Reality Check to Profitabilty Results

• Consistent Methodologies• Single Reconciliation

Choose the Right Approach3


Non-Interest Income and Expense Allocations4

on interest inco e an e pense allocations

en allocatin non interest inco e an e penses on t e P state ent it is i portant to consi er t e follo in factors

• ata availability an i ensionality st ave s pportin ata at t e level yo ant to analy e

• et o olo ies f ll absorption vs activity base costin approac es

• Acco ntin for corporate over ea


F ll absorption approac to allocations

is approac ses rivers to allocate all bac o ce costs o t to eac profit center ac cost center ses appropriate rivers an allocation percenta es

Pros:

• Allocates all costs

• a rees to res lts

• easy to e plain ana e

Cons:

• oes not reveal e cess capacity

• oes not i entify reso rce tili ation properly

• penali es profit centers for bac o ce ine ciencies



Activity base costin approac to allocations

is approac eter ines t e cost per transaction or activity ic can t en be applie to transaction vol e to eter ine total costs for allocation A fe co on activitybase costin et o s are

• Percentage Driven at er in percenta e ter s t e a o nt of a f nctions ti e evote to an activity itable for areas it non repetitive f nctions ar etin

- Pros asy to i ple ent an e plain oo involve ent fro t e or ani ation - Cons ata collection res rvey fails to i entify e cess capacity less acc rate

• Time Capture Driven capt re ti e fro applications p nc car s etc oo for prof services

- Pros reat for e icate ti e to specific pro cts an c sto ers - Cons Fails to i entify e cess capacity e ployee resistance

• Time-Driven at ers ti e re ire to perfor i erent activities an ltiplies vol es to eter ine t e total ti e perfor e an percenta e of e ort oo for areas it repetitive tas s eposit processin

- Pros i entifies e cess capacity - Cons ata availability ata vol e can be c berso e to ana e

• Hybrid co bination of above approac es



Factors to consi er in loan loss provision assi n ent

• ata availability

• Pro ct type

• Cre it is is ratin Cre it core

• Assi n ent et o all at ori ination apply over a certain perio set perio loan ter

• i in i erences

Assignment of the Loan Loss Provision and Risk Based Capital5

RISK RATING CODEPRODUCT CATEGORY 1 2 3 4 5 6 7

Commercial Loans 0.50% 0.75% 1.00% 1.00% 3.00% 5.00% 15.00%Agricultural Loans 0.50% 0.75% 1.00% 1.00% 3.00% 5.00% 15.00%Municipal Loans 0.50% 0.75% 1.00% 1.00% 3.00% 5.00% 15.00%Consumer Secured 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%2nd Mortgages 0.50% 0.75% 1.00% 3.00% 5.00% 7.50% 15.00%Home Equity Loans 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%Personal Loans 0.50% 0.75% 1.00% 3.00% 5.00% 7.50% 15.00%Consumer 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%Auto Loans 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%Overdrafts 0.50% 0.75% 1.00% 3.00% 5.00% 7.50% 15.00%Mortgage Loans 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%Participations 0.25% 0.50% 0.75% 1.00% 3.00% 7.50% 15.00%

Credit Score Bands 800 750 700 650 600

3.00% 5.00% 15.00%

3.00% 5.00% 15.00%

3.00% 5.00% 15.00%

3.00% 7.50% 15.00%

5.00% 7.50% 15.00%

3.00% 7.50% 15.00%

5.00% 7.50% 15.00%

Loan Balance Product Type RatingAssigned

LLP%Calculated

LLPLoan A $ 100,000 Commercial 4 1.00% $ 1,000

Loan B $ 100,000 Mortgage 1 0.25% $ 250


Capital Assi n ent e latoryis ei te Assets approac ses re latory i ance relatin to asset cate ories an capital percenta es


Pros+ Cons-

eco en ation!

• asy to i ple ent

• stifiable

• ea ily Available ates

• nly consi ers Cre it is

• oes not acco nt for iabilities or t er Assets

• oes not acc rately eas re t e instit tion s ris

• till nee to allocate o n fro total ban level

nly se as an intro ction to t e overall concept

There are three common options for assigning risk-based capital - regulatory, peer-based, and multifactor matrix.


Capital Assi n ent Peer baseConsi ers eac line of b siness a stan alone entity ses peer infor ation for t ose s to eter ine ar et capital ratios


Pros+ Cons-

eco en ation!ay be sef l in certain cases

• partial analysis

• ase on e ternal ob ective ar et ata

• stifiable

• i c lt to fin peer ata

• Peers ay be i erent an non co parable

• or ali in capital ratios can be i c lt

• oes not acco nt for iversification

• nly assi ns to not ot er i ensions


Capital Assi n ent lti factor atriAssi ns ei tin s to ris cate ories cre it operational an factors in t e ris s in erent in in ivi al pro ct ro ps co ercial loans cons er loans cons er As


Pros+ Cons-

eco en ation!ost acc rate et o ot er t an a e icate application

• Acco nts for t e vario s ris s it in t e institution

• Consi ers liabilities an ot er assets

• Collaborative

• stifiable

• ei tin s are s b ective

• Can be i c lt to et consens s on ratin s

• ess strai tfor ar to e plain


o e best practices to consi er

• Fin yo r level at s its yo r oals

• et b y in fro cons ers of analysis yo plan to pro ce

• Al ays be able to eco pose to s o etails an calc lations

• cate yo r or ani ation abo t profitability an F P

• efine refine refine contin e to i prove an en ance yo r approac


A io oft are s nifie Perfor ance ana e ent ol tions

Delivering a Financial Planning and Decision Support Platform for Financial Institutions

Ali n b siness realities an financial plans it t is inte rate perfor ance ana e ent platfor esi ne for financial instit tions A io oft are elivers sop isticate plannin reportin an ecision s pport f nctions in a sin le sol tion

funds transfer pricing & profitability management

reporting & analytics

incentive compensationmanagement

loan portfolio analysis

budgeting &forecasting

reenb r ite Portlan p one fa a io ep co

strategymanagement

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