March 11 2015 Performance Measurement Strategic Management Profit

March 11, 2015 Performance Measurement Strategic Management Profit & Process Improvement Board & Management Advisory Services Financial Advisory

Product and Customer Profitability 1

Whole Bank Profitability Measurement Return On Average Assets Reflects the institution’s return on the resources (assets) deployed. Net Income Average Total Assets Return on Average Assets (ROAA) = Target - ROAA > 1. 00% or 100 Basis Points 2

Whole Bank Profitability Measurement Return On Average Equity Reflects the institution’s return on the shareholder’s investment (equity). Net Income Average Stockholder’s Equity Return on Average Equity (ROAE) = Target - ROE > 15. 00% 3

Whole Bank Profitability Measurement Net Interest Margin The difference between interest income and interest expense expressed as a percentage of average earning assets. Net Interest Income Average Earning Assets Net Interest Margin (NIM) = Target - NIM > 4. 00% or 400 Basis Points Now, with a low rate environment…> 3. 50% is new norm 4

Whole Bank Profitability Measurement Yield on Earning Assets Total interest income expressed as a percentage of average earning assets. Interest & Dividend Income Average Earning Assets Yield on Earning Assets = Target YOEA > 4. 00% or 400 Basis Points 5

Whole Bank Profitability Measurement Cost of Funds Total interest expense expressed as a percentage of average interest bearing liabilities & non-interest bearing deposits. Interest Expense Average interest-bearing liabilities & non-int. bearing deposits Cost of Funds = Target Cost of Funds < 0. 75% or 75 Basis Points 6

Whole Bank Profitability Measurement Efficiency Ratio Depicts how much in operating expense to generate $1 of revenue. The lower the ratio, the more efficient the organization. Efficiency Ratio = Operating Expense Net Int. Income + Non-Interest Income Target – Efficiency Ratio 50 -60% An efficiency ratio of 55% means it cost 55 cents to earn $1. 00 worth of revenue. 7

Whole Bank Profitability Measurement Net Interest Margin Depicts operating expense as a percent of average assets. Operating Expense Average Assets Expense Ratio = Target – Expense Ratio 2. 50% - 3. 50% Expense ratio is driven by bank strategy. The lower the ratio, the more efficient the bank. 8

Profitability Information: Why Do You Need It? Profit Continuum: Whole Bank Return on: Assets or Equity Net Interest Margin YOEA Fee Income Cost of Funds Efficiency Ratio 9 Expense Ratio

Profitability Information: Why Do You Need It? Profit Continuum: Dupont Drill Down Net Interest Margin (NIM) Organizational Unit Spread Product Spreads Interest Rate Risk Customer Spreads Funds Transfer Pricing (FTP) 10

Profitability Information: Why Do You Need It? Product Profitability: Loss Leader Theory Banks Satisfactory Profitability * 33. 33% Profitable** 22. 22% Unprofitable 44. 44% Thrifts 22. 22% 44. 44% 33. 33% *Satisfactory Profitability is > 1. 00% pretax return on portfolio balances. **Profitable is 0% - 1. 00% pretax return on portfolio balances. Portfolio groups include: C&I loans, commercial real estate loans, residential real estate loans, consumer loans (including home equity), DDA checking, NOW checking, savings, money market, CD's. Source: The Kafafian Group 3 Q 14 Profitability Peer Group. 11

Profitability Information: Why Do You Need It? Branch Non-Interest Expense Source: The Kafafian Group profitability peer database 12

Profitability Information: Why Do You Need It? Branch Indirect Expense Source: The Kafafian Group, Inc. 13

Profitability Information: Why Do You Need It? Case Study: Commercial Loan Product Source: The Kafafian Group, Inc. 14

Profitability Information: Why Do You Need It? Case Study: Mortgage Lending Department Source: The Kafafian Group, Inc. 15

Profitability Information: Why Do You Need It? Case Study: Trust Department Source: The Kafafian Group, Inc. 16

Profitability Information: Why Do You Need It? Product Profitability Decision Tree 17

Profitability Measurement Organizational Profitability 18

Profitability Measurement Organizational Profitability – Typical Structure Board Audit Officer President/CEO Senior Lender Commercial Credit Branch Admin Branches Operations Marketing HR IT Payroll Consumer Deposit Ops Training Residential Facilities/ Security Loan Ops/ Servicing 19 Compliance Finance

Profitability Measurement Product Profitability 20

Profitability Measurement Product Profitability 21

Profitability Measurement Customer Profitability 22

Profitability Components Funds Transfer Pricing - FTP 23

Profitability Components Funds Transfer Pricing - FTP 24

Profitability Components Funds Transfer Pricing - FTP 25

Profitability Components Funds Transfer Pricing – Actual Spread Versus FTP 26

Profitability Components Capital Assignment – Risk Adjusted Return on Capital (RAROC) 27

Profitability Components Capital Assignment – FRB Risk Categories 28

Profitability Components Capital Assignment – RAROC Sample 29

Profitability Components Capital Assignment – RAROC Customer Example 30

Profitability Components Capital Assignment – What’s Your “Well Capitalized” 31

Profitability Components Cost Assignment 32

Profitability Components Cost Assignment 33

Profitability Components Cost Assignment 34

Profitability Components Cost Assignment – Step Variable Cost 35

ROI Exercise Money Market Campaign 36

ROI Exercise Credit Card vs. HELOC 37

ROI vs. ROE Credit Card vs. HELOC 38

Customer Profitability Exercise RAROC 39

Jeffrey P. Marsico Executive Vice President Ph: 973. 299. 0300 x 120 Email: jmarsico@kafafiangroup. com www. jeff-for-banks. blogspot. com Performance Measurement Strategic Management Profit & Process Improvement Board & Management Advisory Services Financial Advisory