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), 118-131

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), 118-131

2. Paper in Journal of Marketing 2 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), 118-131. © 2011, American Marketing Association

4. Emphasize the importance of reporting forward-looking metrics

5. Propose customer equity reporting (CER) and the customer equity sustainability ratio (CESR) as potential means to increase transparency in financial statements

6. Provide stakeholders with valuable information about the long-term value of a customer base

7. Argue that more forward-looking metrics might have diminished the devastating consequences of the current financial crisis3

9. Total earnings of the soccer club from ticket sales: $100,000,000 ($20,000,000 each year)4

11. Discounted net present value of total earnings: $75,815,7355

12. European Union’s Trouble with Greece 6 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

13. Securitization in Financial and Non-Financial Industries (e.g., Bermes 2011; Bessler 2007; Jobst 2002) 7

15. Amortization can be paid e.g. annually or at the end of the contract period (bullet loan) depending on the loan structure

16. Interest is paid by borrowers constantly (often monthly or annually) on loan volume outstanding

17. Banks earn money from the margin between the interest rate of the loan and the refinancing costs minus provisions for expected loan losses

18. Banks receive the interest margin constantly over the lifetime of the loan contract (for bullet loans)t1 to tn: interest and amortization loan borrowers 8

20. Loans are packed and structured into investment tranches with different underlying risk levels

21. Tranches are distributed to investors

22. A trustee collects interest and amortization cash flows from borrowers and redirects them to investors

23. Investors face the risk of loan defaultst1 to tn: interest and amortization t1 to tn: interest and amortization loan borrowers 9

24. Underestimated Risk in Securitized Assets “First round“ collateralized debt obligations (CDO) Securitization “Second round” collateralized debt obligations (CDO2) Securitization 10

26. Coval, Jurek, and Stafford (2009)

27. Franke and Krahnen (2008)

28. Lockwood, Rutherford, and Herrera (1996)

29. Luo, Tang, and Wang (2008)

32. Calem and LaCour-Little (2004)

33. Jones (2000)

34. Purnanandam (2009)

36. The banks each issue a five-year loan volume of $100,000 to customers at the beginning of each year

37. The annual net interest margin of the loans is 1% (5% interest rate; 3.5% refinancing expenses; 0.5% loan loss provisions)

38. No other deductions or costs occur

39. Discount rate is 10%

40. The non-securitizing bank gets the interest income at the end of each year

41. 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

42. Customer equity is valued as of the end of each year

43. Equity is $30,000

44. We analyze two cases:

45. Distribution case: The banks pay out all of their earnings as dividends at the end of each year

46. Reinvestment case: The banks reinvest the earnings at a return rate of 10%12

47. Banking Example: Non-Securitizing Bank 13

48. 14 Banking Example: Securitizing Bank

49. 15 Banking Example: Effects of Securitization on Earnings (Distribution Case)

50. 16 Banking Example: Effects of Securitization on Return on Equity (Distribution Case)

52. CER publishes detailed customer structures with related earnings and costs in absolute numbers

54. CESR identifies shifts in value realizations over time

55. CESR reports the sustainability of the bank’s earnings as a relative number in a simple and substantial way17

57. Relationship Between Customer Equity (CE) and Customer Equity Sustainability Ratio (CESR) 19 CE (high) Short-TermProfit Realizationwith a StrongCustomer Base Long-TermValue Creationwith a StrongCustomer Base CESR (low) CESR (high) Short-TermProfit Realizationwith a WeakCustomer Base Long-TermValue Creationwith a WeakCustomer Base CE (low)

58. 20 Banking Example Revisited: Effects of Securitization on CE (Distribution Case)

59. 21 Banking Example Revisited: Effects of Securitization on CESR (Distribution Case)

60. 22 Empirical Study About Transparency of Securitization in Banks’ Financial Reports (1/2)

61. 23 Empirical Study About Transparency of Securitization in Banks’ Financial Reports (2/2)

63. Countrywide provides a detailed view of the shift from long-term value creation to short-term profit realization

64. Countrywide was heavily engaged in subprime mortgage-backed securities (MBS) transactions

65. Countrywide needed a rescue from Bank of America in February 2008

66. As a subsidiary of Bank of America, Countrywide no longer publishes its own financial statements, so our analysis comprises 1998-200724

67. 4 Empirical Study of Countrywide:Securitization of Mortgage Loans Total Mortgage Loans Volume (in m USD) 468,172 499,301 123,969 68,923 415,634 66,740 92,881 363,364 434,864 251,901 4% 5% 96% 95% 90% 89% 86% 86% 82% 72% 65% 59% 2005 2001 2006 2000 1999 2007 1998 2004 2003 2002 % of Volume of Mortgage Loans Hold % of Volume of Mortgage Loans Sold 25

68. Empirical Study of Countrywide:Earnings Structure 26

69. 27 Empirical Counterfactual Analysis of Countrywide: Total Earnings

70. 28 Empirical Counterfactual Analysis of Countrywide: Difference in Total Earnings

71. 29 Empirical Counterfactual Analysis of Countrywide: Customer Equity

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

73. 31 Empirical Counterfactual Analysis of Countrywide: Factors in CESR

74. 32 Securitization in Industries Outside Banking (1/2)

75. 33 Securitization in Industries Outside Banking (2/2)

77. CER and CESR as forward-looking customer metrics provide stakeholders with transparency about the long-term value of a firm’s current customer base

78. CESR can better identify shifts in value realizations over time

79. CESR reports the sustainability of the firm’s earnings in a simple and substantial way

80. CER and CESR provide insights into how investors and firms can be supported to avoid some of the challenges of a future financial crisis34

81. Customer Equity Sustainability Ratio: A New Metric for Assessing a Firm’s Future Orientation Need more Information? Contact one of us! 35