The Domestic Commercial Banking Business

1. The Domestic Commercial Banking Business Session 4: 1/17/14 J. V. Rizzi

2. The Domestic Commercial Banking BusinessIntroduction • Population • Why it is different • Financial Crisis The Domestic Commercial Banking Business

3. The Domestic Commercial Banking BusinessEconomics Business Model – Exhibit I - Spread Illusion -Leveraged Yield Curve Carry Trade – Credit and Mismatch Risks -Other – Credit, Rates, Trading and Services Valuation – Exhibits II and III -Opaque -Shared Cost Base -Cross Subsidies -Government Subsidies Governance Regulation The Domestic Commercial Banking Business

4. The Domestic Commercial Banking BusinessWhat Happened – Banks Think With Their Capital Eroding Core Spread Model Increased Risk, Leverage and Assets, To Cover Eroding Profitability Nominal ROE Focus Insufficient Capital to Absorb Eventual Losses Failure of Risk Management – Peso Risk – The Original Black Swan Result Catastrophe Re-Regulation Quantitative Easing – Depressed NIM, Search for Yield The Domestic Commercial Banking Business

5. The Domestic Commercial Banking BusinessConclusion and Observations Trapped Capital Activists Post QE Return of Deposit Value Consolidation Technology Based Models Issues Governance / Incentive Compensation Regulation The Domestic Commercial Banking Business

6. The Domestic Commercial Banking BusinessExhibit I – Economic Model of a Bank Customers + - +NII -Expenses - PLL NIBT -Taxes Shareholders NI Retained Earnings Dividends • Operating Costs • Shared Expenses • Overhead • Distribution • Operations • Interest • Total Expenses Fees Pooled Resources Interest Income <Interest Expense> NII Capital Pool LLR Equity The Domestic Commercial Banking Business

7. The Domestic Commercial Banking BusinessExhibit II – Value Creation ROE = NI × S × A S A E Ke = Rf + Bf(MRP) = DDM = ff CF = NI – ∆A (TCR) EVA = NI - Cc The Domestic Commercial Banking Business

8. The Domestic Commercial Banking BusinessExhibit III - Relationships V = NOPAT + TD +/- (FD, Subsidies….) WACC = NOPAT + I(ROA-WACC)T WACC + WACC (1+WACC) M = ROE – g B Ke – g P = M ÷ ROE E B The Domestic Commercial Banking Business

9. The Domestic Commercial Banking BusinessRelationships Crisis Pricing Distressed Banks TBV <LL Years 1-2> +Earns Years 1-2 ATBV ÷ # Shares Warranted Value Per Share × Discount Offer The Domestic Commercial Banking Business

10. Decoder Sheet NII Net Interest Income LLR Loan Loss Reserves NIBT Net Income Before Taxes NI Net Income S Sales A Assets Eq Equity DDM Dividend Discount Model Rf Risk Free Rate BT Beta MRP Market Risk Premium FF Fama French 3 Factor Model CF Cash Flow TCR Target Capital Ratio EVA Economic Value Added Exp Non Interest Expense Cc Cost of Capital NOPAT Net Operating Profit After Taxes TD Tax Benefits of Debt FD Financial Distress WACC Weighted Average Cost of Capital I Investment T Competitive Advantage Period g Growth M Market Price B Book Value ROE Return on Equity Ke Cost of Equity E Earnings P Price NIM Net Income Margin PLL Provision for Loan Losses The Domestic Commercial Banking Business

11. The Domestic Commercial Banking BusinessCase Studies – Exhibit IV SIFI/TBTF Traditional Banks JPMC (JPM) Wells (WFC) Citigroup (CIT) Investment Banks Goldman (GS) – 2005 Annual, 2013 Changes Morgan Stanley (MS) Community Banks – TSTS PACW JAXB The Domestic Commercial Banking Business

12. The Domestic Commercial Banking BusinessSIFI/TBTF – Traditional BanksJ P Morgan The Domestic Commercial Banking Business

13. The Domestic Commercial Banking BusinessSIFI/TBTF – Traditional BanksWells Fargo The Domestic Commercial Banking Business

14. The Domestic Commercial Banking BusinessSIFI/TBTF – Traditional BanksCitigroup The Domestic Commercial Banking Business

15. The Domestic Commercial Banking BusinessSIFI/TBTF – Investment BanksGoldman Sachs The Domestic Commercial Banking Business

16. The Domestic Commercial Banking BusinessSIFI/TBTF – Investment BanksMorgan Stanley The Domestic Commercial Banking Business

17. The Domestic Commercial Banking BusinessSIFI/TBTF – Community Banks - TSTSPacific West The Domestic Commercial Banking Business

18. The Domestic Commercial Banking BusinessSIFI/TBTF – Community Banks - TSTSJacksonville Bancorp The Domestic Commercial Banking Business