A New Approach to Manage Profitability THC FUND TRANSFER PRICING (FTP) MODEL

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1 , A New Approach to Manage Profitability THC FUND TRANSFER PRICING (FTP) MODEL THC Asset-Liability Management (ALM) Insight Issue 3 Post 2009 financial crisis, a new approach to enhance profitability is needed. Calculating profit is deceptively simple but enhancing profit is a challenge, because every balance sheet action involves credit, liquidity and interest rate risks. There are profitability measures aplenty: Earnings-at-Risk (EaR), Return on Equity (ROE), Return on Asset (ROA), Net Interest Margin (NIM), Option Adjusted Spread (OAS), Risk-Adjusted Return on Capital (RAROC), just to list a few. Can you use many risk measures such as CECL, Duration, Liquidity Coverage Ratio, and EVE Ratio to enhance profits? How to adjust contract profitability to achieve corporate goals? Adjust the offer rates, broaden product offerings, seek participation opportunities? This article explains. Introduction Calculating profit is deceptively simple but enhancing profit is a challenge, because every balance sheet action likely involves multiple risks: credit, liquidity and interest rate risks. You have profitability measures aplenty: Earnings-at-Risk (EaR), Return on Equity (ROE), Return on Asset (ROA), Net Interest Margin (NIM), Option Adjusted Spread (OAS), Risk-Adjusted Return on Capital (RAROC), just to list a few. But how are they related? Can you use many risk measures, such as CECL, Duration, Liquidity Coverage Ratio, and EVE Ratio to enhance profits? How to adjust contract profitability to achieve corporate goals? This article explains. THC Fund Transfer Pricing (FTP) is a financial management tool to measure risk-adjusted profitability of business units and lending/investment products. FTP is an important tool for banks and credit unions because it ensures consistency of profitability measurements across different products that are otherwise difficult to aggregate to enterprise-wide profitability. For this reason, product pricing, business units strategies, and enterprise capital planning are made consistent in achieving the Bank s risk-adjusted profitability. Furthermore, FTP provides a systematic procedure for risk transfer, funding strategies and capital planning ROE (return on equity) and ROA (return on assets) are commonly used as profitability measures. But how much Risk Capacity, in liquidity, credit and interest rate risks, have you used from your balance sheet to achieve the profitability goal? How should you change the product pricing and product mix to reach the target risk-adjusted return for your stakeholders? How does the funding mix affect the ROE? In short, how does each revenue driver affect your ROE? FTP provides the solutions. And the progress in risk models post 2009 financial crisis has made FTP modeling widely available to banks of any size making use of the recently introduce risk measure. THC FTP model describes this new approach to measure profitability. FTP has been used to manage banks since late 1980 s. There are typically two traditional approaches. The single-pool approach assigns a hurdle for a business unit depending on the bank s organization. ALCO decides the hurdle rate for the product type, such that the product pricing should garner returns exceeding the hurdle rate. The multi-pool approach, extending from the single-pool approach, assigns multiple hurdle 1

2 rates to segmented pools depending on the pool characteristics. The profit is measured as the spread between the lending rate and the hurdle rate. This hurdle rate is called the Transfer Pricing Rate. But these approaches have significant limitations in their ability to capture profitability of products. For example, neither the single-pool approach nor the multi-pool approach can capture the embedded options in the products offered to customers in lending. Also, these traditional transfer rates do not capture the credit risk and slope of the yield curve accurately and are not consistent with risk measures such as durations, which are sensitive to the shape of the yield curve, caps/floors of ARMs, repricing assumptions, and callability of bonds and loans. In addition, these approaches do not incorporate the management risk preference or aversion to their interest rate risk, credit risk, liquidity risk and capital risk. Risk preferences depend on the bank s culture that has to apply consistently to product pricing and business units to be aggregated to the enterprise level. THC FTP model overcomes these limitations. THC FTP approach uses the economic approach. 1 Our FTP methodology uses robust financial models to value embedded options, credit risks and liquidity spreads. The use of economic valuation in FTP is crucial because the profitability measure is an input to the offer and funding prices to the capital market. Capital market prices are central to all profitability calculations in the FTP. The valuation models determine the profit, measured in rate spreads (called clean OAS) and dollar ($ profit), for each lending and funding product. These account level profits are aggregated to the enterprise level where the profitability of each business unit is measured as the Risk-Adjusted Return on Capital (RAROC). FTP can then be used in proforma financial statements, disaggregated to each business unit or loan types, and the results are consistent with the Economic Value of Equity (EVE) report and the Earnings at Risk (EaR) report. Consistency is maintained between economic valuation and earnings projections and maintained over alternative disaggregation of the balance sheet analysis. Diagram 1. FTP interfaces between Lending and Corporate Strategies Sectors RAROC -fixed 11.56% -variable 15.52% -10 year variable 13.05% -Consumer Loans 9.00% RAROC ranks profitability of sectors or loan types in accordance with the corporate risk preference and strategic plans Loan rates determine the rates of return after risk charges Products By Loan Rate sheet OFFER RATES -1-4 Family Mortgage 3.750% -2nd Closed End 5.250% -Construction and Land Development Loan 6.125% -Multi-Family Mortgage % -Commercial Loan 4.625% -Auto 3.250% 1 THC approach is analogous to Moody s Analytics September 2011 Economic approach and Disaggregate a transfer price into different components and associated premia 2

3 In particular, this article shows the Risk-Adjusted Return on Capital (RAROC) of loan types can affect the Loan Offer rates, and conversely, how the loan offer rates affect the RAROC, the profitability to the bank s stakeholders. The feedback loop between senior management and lending officers is depicted by the diagram below. The implementation of fund transfer pricing methodology must necessarily depend on management s risk culture and the organization structure. Therefore, the purpose of this document is not to propose a precise implementation, but instead a framework within which each bank can adjust the methodology appropriate for management s business purposes, while benefiting from the methodology s consistency and accuracy in measuring profitability. THC FTP Model Advantages A consistent profitability measure from loan pricing to risk-based earnings allows for the decomposition of the contribution margin for management into its constituent components: option risk, liquidity risk, credit risk, interest rate risk, and treasury contribution. As a result, senior management can formulate the Risk Adjusted Return on Capital (RAROC) to determine the profitability as returns on capital after adjusting for the balance sheet requirements and management s risk preference. For example, the traditional banking business model (NIM focused) has a fundamental tension between growth and profitability. Excess contract profitability can lead to slow asset growth and this may eventually lower corporate profitability. Conversely inadequate contract profitability may result in high asset growth resulting in capital deficiency. This example highlights the importance of setting the appropriate NIM to achieve the corporate goal taking senior management risk preferences and growth targets into account. 2 Fund Transfer Rates are based on capital market interest rates using account level information. 3 By working at the account level and evaluating each transaction, profitability can be measured accurately by Clean OAS, which is constant in the projection of cashflows for the life of loans. While the clean OAS is constant, the Transfer Pricing Rate is not locked-in as the THC FTP model transfer pricing rate reflects the change in the market conditions as interest rates rise and fall. FTP enables ALCO to monitor and manage interest rate risk using mismatch in key rate duration and determine the profit spread due to the shape of the yield curve, particularly, a rising yield curve. Such a measure is called the Treasury contribution. ALCO can work with lending officers to determine the pricing of embedded options, such as caps and floors, offered to customers. Likewise, the FTP also enables ALCO to determine the credit risk charge, increasing the profitability of the lending product portfolio. Senior Management can monitor the profitability by loan types, groups of loan types (called sectors), or business units using RAROC, whereby the bank culture is taken into account, in addition to financial measures such as balance sheet credit concentration risk, market liquidity, and the target of distributable profits. 2 I like to thank Dennis Guida, Carpenter Advisory, for providing me this example 3 THC uses the measure, clean OAS, avoided the transfer rate being locked-in for the life of the loan as discussed in Moody s Analytics September 2011 pg 8 Funds Transfer Pricing Approaches 3

4 THC FTP Model: Theory and Approach THC profitability measure is consistent with FHLB Advisory Bulletin AB Acquired Asset Management Price Risk Governance recommended methodology, which is the Risk-Matching Liabilities methodology based on assembling a risk-matching set of liabilities, and calculating OAS as the difference between (a) the asset OAS, and (b) the weighted average funding OAS. THC FTP model is also consistent with the Match-Maturity or Co-Terminus Method, which Moody s described as the preferred FTP method expected cash flows are calculated from transactional level contractual features stored in the bank s systems of record. Behavioral assumptions are applied based upon common practice and current experience for amortization, prepayments options and other embedded features. 4 THC FTP model differs from Moody s model in that the THC model links FTP analysis to ROE and ROA, and the Model also provides prescriptive implementation details, supported by risk measurement methodologies. The Model uses the Treasury curve or the Swap curve as the Transfer Pricing curve. Financial models are applied at the account level to calculate the yield (or rate) attribution. The financial model can determine the components of the yield of a loan. In particular, a loan rate is the sum of the following components: Time Value: The portfolio yield of Treasury securities that replicate the projected cash flows of the loans or any balance sheet instrument. Option spread: The change of the yield with and without volatilities, whereby there is no option spread when there is no interest rate volatility Credit spread: The credit loss model uses the PD (probability default) and LGD (loss given default) approach. The credit spread is the change of credit spreads when the recovery ratio is changed to 100 percent, with no LGD. Servicing cost: The annual marginal cost in maintaining the account Clean OAS: The loan rate or deposit offer rate yield net of the above components, whenever applicable. THC FTP model provides a consistent profitability management structure in three levels: (1) Customer Service Level to determine product pricing; (2) ALCO Level to determine the transfer pricing rate to each business units or sector of product types; and (3) Senior Management Level to determine RAROC, which enables senior management to determine the target product pricing. The three levels of profitability measures allow for managers to focus on their own roles and responsibilities while maintaining consistency in achieving higher risk-adjusted profits. On the customer service level, the THC FTP model analyzes profitability on the account level. The Clean OAS is the basic profitability measure from which other profit contributions will be added. 5 The loan level profitability is then aggregated to the business units. Using FTP, ALCO can determine the funding cost of each business unit or loan type sectors, such as allocating deposit accounts assigned to investments. One example of an allocation is pro-rata assignments 4 Moody s Analytics September 2011 pp 8 on Matched Maturity approach. 5 The clean OAS is consistent with the Economic Approach to Calculate Funds Transfer Prices, pg 13. 4

5 Rates % of the total funding cost to each sector of the asset portfolio based on outstanding balance. This Transfer Pricing Rate is called the weighted average funding rate (WAFR). The profits adjusted for the funding cost is called the Risk-Adjusted Margin (RAM). Senior management can use the Risk-Adjusted Margin to determine RAROC which can be used for capital planning and strategic planning such that the balance sheet can be adjusted to be consistent with the bank s risk preference and balance sheet or regulatory requirements. THC FTP Model: Description For clarity of exposition, a hypothetical bank is used in describing the THC FTP model. Any resemblance of the numerical example to a bank s balance sheet would be coincidental. For these examples, the transfer pricing curve is assumed to be Treasury yield curve. The transfer pricing curve should be considered the reference curve. The FTP Report will extend this analysis to take the funding cost of the Bank into account. Customer Service Level: Rate Sheet Yield Attribution Report 6 The Yield Attribution Report begins from using the Bank s Rate Sheet. Using THC valuation model, each loan type yield attribution chart can be generated as depicted below. 7 Figure 1 Hypothetical Bank Yield Attributions of Loan Types 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - (1,000) Loan Types time value option spread credit spread clean OAS servicing 6 Moody s Analytics September 2011.p g 9 A Simple Funds Transfer Pricing Examples provides only simple and special cases. The methodology here provides a general approach for the entire balance sheet. 7 Moody s Analytics September 2011.pg 13 refers to the decomposition as follows: Reference rate: time value (treasury rates);funding liquidity spread: matching rate time value; Contingent liquidity spread use Contingency Funding Plans (or charge later allocated capital); Credit spread; Option spread; Commercial Margin risk-adjusted margin (clean OAS Funding liquidity spread) 5

6 Figure 1 shows the yield attribution, where each component of the rate is defined in the previous section. The loan rates are provided by the bank s rate sheet. The table in Appendix A shows that the weighted average life can exceed the duration significantly, depending on the loan type. The results highlight the deficiency of using the Single-Pool or Multiple-Pool approach, which cannot determine the transfer pricing rate that would match both the cash flow for liquidity purpose and match duration of interest rate risk to determine the net profit, isolated from the yield curve shape. The THC FTP model approach uses the option spread as a component to reconcile in managing liquidity and interest rate risks. The numerical values of Figure 1 are presented in Appendix A. This report shows only the product level and not the account level, without breaking down the residential loans into FRM15, FRM30, ARM 1/1 ARM 5/1 for example and for illustration, the report assumes FICO 750 and LTV 80% for all consumer and residential loans. The calculations are done on the account level, and the report is presenting only the weighted average numbers. ALCO Level: Fund Transfer Pricing Report Fund transfer pricing report is similar to the rate attribution report. But the account level attribution is aggregated to business units or sector levels. For clarity of exposition, this example assumes that the transfer pricing rate to be the Weighted Average Funding Rate (WAFR), by assuming that the funding is based on the average cost of deposits and borrowings, without assigning particular fundings to different asset types. For illustrative purpose, only sectors Cash, Investment, Loans, Non-Maturity Deposit account, and Time Deposit are considered here and this example does not consider FTP for business units. The WAFR is calculated to be 1.15%. The difference between the Time Value and WAFR is added to the clean OAS, which is the Risk-Adjusted Margin (RAM). Referring to Figure 2, in a positive rising Treasury yield curve regime, long term asset would have a Time Value higher than the WAFT, and therefore, when these assets are funded by the WAFR would have a higher reported profit. This component of profit is called the Treasury Contribution. That is, any gap in the duration mismatch is managed by the treasury function. Meanwhile, cash funded by WAFR has a negative RAM, as expected. The treasury contributions are the profit component generated by centralized measurement and management of interest rate risk, and the measure is defined as the Time Value net of the WAFR. Figure 3 the treasury contribution presents the treasury contribution for each balance sheet sector. The numerical values of Figure 2 are provided in Appendix B. 6

7 Rates (%) duration and WAL (year) Figure 2: Hypothetical Bank Fund Transfer Pricing Report 6,000 5,000 4,000 3,000 2,000 1,000 - (1,000) (2,000) Cash & Cash Equivalent TD Investment Loans NMD Cash & Cash Equivalent TD Investment Loans NMD Balance Sheet Sectors 12,000 10,000 8,000 6,000 4,000 2,000 RAM Option sp Credit sp WAFR WAL dur - The Time Deposit funding rate is lower than WAFR by 9 basis points while the loan rate is higher than the WAFR by 6 basis points. In total, the treasury contribution is 15 basis points. But the treasury contribution with the loans funded by the time deposit must be balanced by the cost of increase interest rate risk, with the combined position being liability sensitive. Treasury contribution relative to the transfer pricing rate is presented below. Table 1. Treasury Contribution by Sectors or Products Product Balance Treasury Contribution Cash & Cash 2,991 (1.63) Equivalent Time Deposit (63,847) (0.09) Investment 16,655 (0.74) Loans 64, NMD (10,322) 0.59 More generally, the Fund Transfer Pricing Chart is presented below. 8 8 Moody s Analytics September 2011.pg 6 and 10 explains the Fund Transfer Pricing chart. In this example, WAFR is used to assign the funding cost to each sector in a systematic and objective way. This example does not deal with the transfer pricing rate determined by different combinations of funding sources. Also, the components of the rates are presented here. 7

8 The construction of the FTP model begins with a loan contract profitability. The loan rate is attributed to the components: time value, servicing cost, option spread, credit spread, and clean OAS. Time value is the cost of matched funding using the chosen transfer pricing curve, in this case, the Treasury Yield Curve. The managing the loan s time value net of that of the deposit is the treasury function, and is called the treasury contribution to the profit margin. Since allocating multiple funding sources to a loan portfolio can be a complex process, this model uses the weighted average funding cost to separate the loan treasury contribution from the deposit (funding) treasury contribution. The loan rate net of the time value is the loan customer contribution to interest income, and that itself has to be decomposed further to identify the net profit, called clean option adjusted spread (clean OAS). On the loan sector or business unit level, profit has to be measured in terms of the funding cost. For this requirement, the Risk-Adjusted Margin (RAM) is defined as the sum of the clean OAS and loan treasury contribution, taking the weighted average funding rate into account. But profitability has to be defined taking corporate preference to achieve strategic goals. The following section explains. Senior Management Level: Corporate Risk Charges and Risk Adjust Return on Capital (RAROC) THC FTP model ALCO Level determines the Risk-Adjusted Margin for each business unit. Senior Management determines the capital charge of the risk exposure of the business unit to the balance sheet. Positive capital charge would set a higher offer rate deterring volume growth while negative risk charge would lower the offer rate to increase volume growth. 8

9 RAROC % The credit risk charge applied to loan types may be affected by each risk driver. The liquidity risk charge applied to investments can be affected by liquidity coverage ratio and the contingency funding plan quantitative assessment report (ref Appendix C a and b). Interest rate risk charge applied to fixed rate mortgage loans relative to the adjustable-rate mortgage loans may be affected by the equity duration as reported in EVE (Economic Value of Equity) report when the duration exceeds the balance sheet duration target(ref Appendix C c). The credit concentration risk on the balance sheet, where the concentration risk can be measured by CECL, current estimated credit loss (ref Appendix C d.) Capital risk charge can be negative when the management seeks faster growth (ref Appendix C e Du Pont analysis.). Value Attribution enables ALCO to determine purchase or sale prices (ref Appendix C f). The capital ratio applied to each business unit can be the same as the bank s tier 1 capital ratio. RAROC is the Risk-Adjusted Margin net of Risk Charges divided by the Capital Ratio. Risk-Adjusted Return on Capital (RAROC) report 4,50 4,00 3,50 3,00 2,50 2,00 1,50 1,00 0,50 - Figure 3.Risk-Adjusted Return on Capital (RAROC) Report -fixed -additional -variable -10 year variable -Consumer Loans Risk-adjusted margin Sector Types Credit charge Duration charge RAROC 18,00 16,00 14,00 12,00 10,00 8,00 6,00 4,00 2,00 - Table 2. RAROC Calculation from Risk-Adjusted Margins Sectors Riskadjusted margin (1) Credit charge Duration charge Capital Ratio RAROC ((1) (2) (3) )/(4) (2) (3) (4) - fixed % 11.56% - variable % 15.52% - 10 year variable % 13.05% - consumer loans % 9.00% RAROC can be used to ranking profitability of the product types or business units taking the risk preferences of the Senior Management to achieve the corporate strategic goals. Figure 3 shows that the variable rate loans have the highest profitability from the corporate perspective. The risk charges can be related to the loan officers affecting the loan offer rates. 9

10 Summary Risk charges are determined by the Senior Management based on their risk preference and balance sheet risk and regulatory requirement. Based on the RAROC analysis, Senior Management may adjust the offer rates to customers in order to change the margin and volume mix. Considerations in determining the Risk Charges are discussed in the following section. Hence, the FTP provides a feedback control loop between the senior management and customers service and product pricing. The Risk Charges can be determined by using multiple stress tests and other risk metrics. Some of the applications are provided in Appendix C. The discussion of the use of risk measures to determine risk charges is beyond the scope of this article. However, one approach would be estimating the potential loss in value under different stress tests. The capital risk charge can be such potential loss in values. Diagram 2: The Feedback Control enabled by the Fund Transfer Pricing Model Account Level Product Pricing Sector/Business Unit Level ALCO Senior Management Level Board Yield attribution Time value Option cost Credit spread Servicing costs Clean OAS Risk-Adjusted Margin Clean OAS adjusted by the Bank/CU funding cost The funding cost is the weighted average funding costs depending on ALCO liability strategy Clean OAS + (Time Value WAFR) RAROC Risk-Adjusted Margin net of Risk Charges to Capital Ratio Risk Charges can be determined by the Risk Capacity (Risk-Adjusted Margin Risk Charges)/Capital_Ratio Use RAROC to adjust Pricing Conclusions Every balance sheet action involves credit, liquidity, where interest rate risks and profitability measures aplenty: Earnings-at-Risk (EaR), Return on Equity (ROE), Return on Asset (ROA), Net Interest Margin (NIM), Option Adjusted Spread (OAS), Risk-Adjusted Return on Capital (RAROC), just to list a few. THC FTP model brings them together in a coherent profitability measurement structure. The Model uses CECL, Duration, Liquidity Coverage Ratio and other risk measures for the management to enhance profits. The traditional banking business model (NIM focused) has significant limitations in measuring profitability to achieve corporate goals. For example, NIM has a fundamental tension between growth and profitability. 10

11 Excess contract profitability can lead to slow asset growth and this may eventually lower corporate profitability. Conversely inadequate contract profitability may result in high asset growth resulting in capital deficiency. This example highlights the importance of setting the appropriate NIM to achieve the corporate goal taking senior management risk preferences and growth targets into account. THC FTP model provides a consistent approach to measure profitability across product types and across levels of management. The model allows for the decomposition of the contribution margin for management into its constituent components, ie option risk, liquidity risk, credit risk, interest rate risk and customer product, and formulates the Risk Adjusted Return on Capital (RAROC) to determine the profitability as returns on capital to achieve corporate goals. THC FTP model ALCO Level determines the Risk-Adjusted Margin for each business unit. Senior Management determines the capital charge of the risk exposure of the business unit to the balance sheet. Positive capital charge would set a higher offer rate deterring volume growth while negative risk charge would lower the offer rate to increase volume growth. Fund Transfer Rates are based on capital market interest rates that are applied to account level and each transaction. ALCO can monitor and manage interest rate risk using mismatch in key rate duration and treasury contribution, and the embedded options are priced in profitability measure. The implementation of fund transfer pricing methodology must necessarily depend on the management risk culture and the organization structure. Therefore, the purpose of this document is not proposing the precise implementation, but rather a framework for each bank to adjust the methodology so that it is appropriate for the management business purpose. I welcome your comments. Regards, Tom Ho PhD President Thomas Ho Company Ltd Tom.ho@thomasho.com

12 Appendix A Yield Attribution of Lending Product Report The report below provides the numerical data for Figure 1. Products time option credit clean RATE By Loan Rate sheet value spread spread OAS servicing WAL eff.dur -1-4 Family Mortgage nd Closed End Construction and Land Development Loan -Multi-Family Mortgage Commercial Loan Farm Land Loan (0.000) Farm Operating Loan Auto (0.000)

13 Appendix B The Fund Transfer Pricing based on the Risk Adjusted Margin The report provides the numerical values of Figure 2. Product Balance Rate Risk-Adjusted Margin = Clean OAS + (time value- WAFA) Cash & Cash Option sp Credit sp WAFR WAL dur 2, (0.848) Equivalent Investment 16, Loans 64, Other Assets 1,002 - (1.115) TD (63,847) NMD (10,322) Other Liabilities (228) - (1.115) Equity 10,

14 Appendix C THC FTP Model Applications in THC Network THC FTP Model is a function within Strategy Development section, where the FTP reports are available. The FTP model is also supported by proforma financial statements and risk reports. The supporting reports and applications are summarized below. The analysis and risk measures are consistent within the THC Network product. The risk charges can be determined by THC Risk Reports. a. Contingency funding plan quantitative assessment report provides the supporting material to determine the liquidity risk charge based on the Risk Capacity. In particular, alternative stress scenarios can determine the target level of liquidity, credit exposure, and interest rate risk exposures. These analyses would enable managers to determine the capital risk charges. b. Directors Dashboard report provides an overview of the risks and profitability of the bank/cu. In particular, the Uses and Sources of Funds summary may suggest adjusting the cash and cash equivalent position to target an optimal liquidity level. The increase in negative treasury contribution will have to be balanced by a positive increase in treasury contribution in other sectors to maintain the same profitability. Management can adjust the liquidity charge to determine the optimal RAROC for each sector. 14

15 c. Key rate duration report identifies how the mismatch in interest rate risk is related to Treasury Contribution to income. The Key Rate Duration report shows more precisely the yield curve risk between the Time Deposit and Loan positions, enabling the treasury to decide on the trade-off between duration and the treasury contribution. KRD measures the sensitivity of each key rate change on the balance sheet position. The interest rate charge can depend on the deviation of the loan portfolio duration from its target. Key rate duration report and the treasury contribution report provide the information to determine the tradeoff between yield curve risk and the profit margin. d. CECL App presents the concentration risk and product relative risks under stresses to determine the credit risk capital charge. For the Hypothetical Bank, the chart shows the increase in CECL is quite significant, suggesting there is a significant concentration risk in loans. The result suggests that the hypothetical banks should consider disaggregating the analysis of the loan portfolio, and the management may need to increase the Credit Risk Charge for the loan pricing. e. Du Pont Analysis presents the rolling up of profits from sectors or business units to the enterprise level. Du Pont analysis provides a comprehensive rolling up of income and expense by sectors of the balance sheet. The roll up of profit by Du Pont analysis is analogous to the rolling up of profit by FTP. Therefore the Du Pont Return on Asset (ROA) can be analyzed in terms of RAROC, and the income of the sectors can be analyzed by Risk Adjusted Margin. 15

16 f. THC Risk-Adjusted Performance (TRAP) report provides the Value Attribution and the Yield Attribution. The report provides price quote and CECL valuation. The report enables the bank to convert rates to price for transaction or origination of loans. 16

17 References 1. Moody s Analytics Implementing High Value Funds Transfer Pricing Systems September Ho, Thomas and S.B Lee The Oxford Guide to Financial Modeling pg 396 Oxford University Press Ho, Thomas, A. Scheitlin, K.Tam, 1995 Total Return Approach to Performance Measurements, North American Actuarial Journal About THC THC is a financial technology company founded by Dr. Thomas Ho, a former professor at New York University, who introduced the first balance sheet valuation (Ho-Lee model 1986) called "option model" by regulators and key rate durations (1992), one of the most popular interest rate risk measures. THC was selected as the sole provider of the risk reporting to all regulated institutions under a federal bank regulator. THC continues to dedicate its research and resources to supporting community banks. THE THC CONTENT IS PROVIDED AS IS, WITHOUT REPRESENTATIONS OR WARRANTIES OF ANY KIND. TO THE MAXIMUM EXTENT PERMISSIBLE UNDER APPLICABLE LAW THC HEREBY DISCLAIMS ANY AND ALL WARRANTIES, EXPRESS AND IMPLIED, RELATING TO THE THC CONTENT, AND NEITHER THC NOR ANY OF ITS AFFILIATES SHALL IN ANY EVENT BE LIABLE FOR ANY DAMAGES OF ANY NATURE WHATSOEVER, INCLUDING, BUT NOT LIMITED TO, DIRECT, INDIRECT, CONSEQUENTIAL, SPECIAL AND PUNITIVE DAMAGES, LOSS OF PROFITS AND TRADING LOSSES, RESULTING FROM ANY PERSON S USE OR RELIANCE UPON, OR INABILITY TO USE, ANY THC CONTENT, EVEN IF THC IS ADVISED OF THE POSSIBILITY OF SUCH DAMAGES OR IF SUCH DAMAGES WERE FORESEEABLE 17