Post on 05-Dec-2014
description
MANAGING BANK RISK
BARBARA FAVA, PFM ASSET MANAGEMENT
JUNE MATTE, PUBLIC FINANCIAL MANAGEMENT
JIM MATTEO, UNIVERSITY OF VIRGINIA
Market Capitalization (Billions)
Change in Market Value
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Dear Sirs,One of my checks was returned from your bank marked ‘insufficient funds’. In view of current developments in the credit market, does that refer to me or to you?
Query to Bank
Credit Rating Trends
Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Oct 2012
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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• Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity.• Source: Bloomberg Finance 4
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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Risks to the University
• Financial– Loss of Principal– Insufficient Liquidity– Access to Credit Markets
• Operational • Opportunity Cost
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Cash & Investment Exposure
Investments
• Principal Risk• Diminished
Market Value• Loss of Credit
Enhancement• Liquidity• Opportunity Cost• Custody
Cash
• Deposit Balances
• Liquidity• Investment
Sweeps
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Investment Custody
“Your Purchasing Card is fine. I’m just checking that your bank hasn’t expired!”
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Operational Risk
• Purchasing Card• Merchant Card Processing• Campus Card• Payroll Card• On Campus Branch/ATM
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Enterprise Management
• Diversity of instruments, parties and potential credit quality
• New paradigm for thinking about banking partners– Fewer highly rated players– Many new entrants in new roles
• Evolution in types of debt instruments available driven by changes in market
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Letter of Credit Provider Ratings
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as of October 2012
• Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity.• Source: Bloomberg Finance
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+
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Manage Risk Across the Spectrum
Letters of Credit/Credit Enhancement/Liquidity
– Put Risk
– Trading Spreads
– 2a7 Issues
Swaps– Counterparty Risk
Lines of Credit
Direct Placements– Acceleration Risk
– Cross Default
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Hierarchy of Credit
Bank Credit Quality
Swaps
Lines of Credit
Direct Placements
Letters of Credit/Credit Enhancement/Liquidity
A
A-/A3
BBB/Baa
A+/A1
AAA/Aaa
AA+/Aa1
AA/Aa
AA-/Aa3
Bank Credit Quality
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Hierarchy of Credit
Bank Credit Quality
Swaps
A
A-/A3
BBB/Baa
A+/A1 Lines of Credit
Direct Placements
Letters of Credit/Credit Enhancement/Liquidity
AAA/Aaa
AA+/Aa1
AA/Aa
AA-/Aa3
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Hierarchy of Credit
Bank Credit Quality
Swaps
Letters of Credit/Credit Enhancement/Liquidity
Lines of Credit
Direct Placements
A
A-/A3
BBB/Baa
A+/A1
AAA/Aaa
AA+/Aa1
AA/Aa
AA-/Aa3
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Hierarchy of Credit
Bank Credit Quality
Letters of Credit/Credit Enhancement/Liquidity
Swaps
Lines of Credit
Direct Placements
A
A-/A3
BBB/Baa
A+/A1
AAA/Aaa
AA+/Aa1
AA/Aa
AA-/Aa3
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Letters of Credit
• Facility expirations in 2011 had minimal impact
• Good pricing– Low VRDB issuance – Lots of competition
• Overall supply and VRDBs supply is low• Banks no longer requiring other
treasury service relationships• Tenors are typically 3 years or less
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Direct Loans
• Borrowers opting for direct loans instead of public sale– Lower transaction costs– Easier implementation – No credit ratings – No public disclosure
• Longer tenors for variable rate transactions (4-10 years)
• Fixed rate typically sold with 20-30 loan and mandatory tender in 4-10 years
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Direct Loans Share VRDBs Risk
• Bank renewal/Refinancing Risk• Obligation to Repay Loan Accelerates at
Term– Many issuers do not have cash on hand or
budget flexibility to cover accelerated repayment
• Immediate acceleration due to rating or default triggers
• Unknown costs related to changing regulatory environmentSource: Moody’s Investors Service
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Direct Loans Reduce Some Risk
• Alternative to Variable Rate Demand Bonds
• Increases availability of liquidity at renewal
• Limited refinancing risk – For VRDBs, failed remarketing can occur
at any time– Credit deterioration of bank or general
market dislocation could result in failed remarketing of VRDBs
Source: Moody’s Investors Service
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Existing Swaps
• Continued focus on counterparty risk– Understand collateral thresholds – Consider replacing counterparties – Understanding Additional Termination Events
(ATEs)
• Treatment of swaps in debt restructuring • Review documents to see whether swap
is tied to existing debt structure (i.e. tied to current LOC provider)
23“LOOKS SOLID ENOUGH TO ME!”
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Holistic Approach
• Cash, Investments, Debt, Operations• Understand enterprise risk • Diversify• Balance Credit Quality, Cost, Service
and Institutional Exposure
Bank Risk Matrix - Debt
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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Long Term Debt Rating
Parent Rating
Bank Rating
Debt Exposure
Swap Counterparty
Bond Trustee
Line of CreditLiquidity and Letters of Credit
Remarketing Agent
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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Cash and Investments Deposit Accounts Savings Accounts Repurchase Agreements Money Market Funds
Commercial Paper and Corporate Notes Foundation Endowment Security Custody
Securities Lending
Bank Risk Matrix - Investment
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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Operations
Banking Services
Payroll Card
Merchant Card Travel & Entertainment Card
Integrated Payables
On Grounds Branch/ATM
Bank Risk Matrix - Operations
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A Case Study in Managing Bank Risk
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Risk Management Efforts
Enterprise RM
Department RM
Event RM
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U.Va. Treasury Dept. RM
1. Adopt a Risk Mgmt. Approach2. Identify Risk Events3. Score Risks4. Develop Risk Response5. Measure and Monitor Risk
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1. Adopt a RM Approach
COSO’s ERM – Integrated Framework
http://www.coso.org/documents/coso_erm_executivesummary.pdf
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2. Identify Risk EventsRisk
CategoriesStrategic, Operating,
Compliance, Reporting Treasury Objective Risk (threat or opportunity)
Strategic Optimize Cash Operations Undefined Risk Tolerance
Strategic Optimize Returns on Financial AssetsMismatch between asset and liability portfolios
Operating Optimize Cash OperationsThe impact of a Reduction in Operating Budget Sources
Operating Optimize Cash Operations Cash Forecast Inaccuracy
OperatingProvide Effective Solutions for Customers
Risk of insufficient debt capacity
ReportingFacilitate Efficient and Cost Effective Access to Capital
Insufficient Timing and Adequacy of External Debt Reporting
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2. Identify Risk Events
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3. Score Risk Exposures
Risk Categories
Strategic, Operating,
Compliance, Reporting Treasury Objective Risk (threat or opportunity)
Likelihood Impact
Total Score
Velocity
(L*I)
StrategicOptimize Returns on Financial Assets
Counterparty underperformance risk
2 4 8 3
Operating Optimize Cash OperationsCounterparty Relationship Team Risk
2 3 6 3
StrategicFacilitate Efficient and Cost Effective Access to Capital
Inadequate liquidity counterparty diversity
2 3 6 3
Operating Optimize Cash OperationsCash Operations Counterparty Failure
1 5 5 5
Operating Optimize Cash OperationsCounterparty Credit Risk - Deposits
1 5 5 5
ComplianceOptimize Returns on Financial Assets Counterparty Fraud 1 5 5 5
ComplianceOptimize Returns on Financial AssetsPoor counterparty internal controls
1 5 5 5
Strategic Optimize Returns on Financial Assets Counterparty key person risk 2 2 4 3
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4. Develop Risk Response
• Retention• Insurance• Avoidance• Mitigation
5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Debt (Pre-2008)
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Treasury Relationship Matrix
Bank of America
Bank of New
York/MellonGoldman
SachsJPMorgan
ChaseMorgan Stanley
Lehman Bros.
Merrill Lynch Wells Fargo
Long Term Debt Rating
Parent Rating AA/Aa1 A+/Aa2 AA-/Aa3 AA-/Aa2 AA-/Aa3 A+/A1 A+/A1 AA+/Aa1
Bank Rating AA+/Aaa --/Aaa --/Aa3 AA/Aaa AA-/Aa3 A+/A1 --/-- AAA/Aaa
Debt Exposure
Swap Counterparty $50 million $50 million
Bond Trustee X
Line of Credit $250 million
Liquidity and Letters of Credit
Remarketing Agent$300 million
CP$82 million
VRDB’s
5. Measure and Monitor Risk U.Va. Bank Risk Matrix - Debt
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Treasury Relationship Matrix
Bank of America/
Merrill Lynch
Bank of New
York/MellonGoldman
SachsJPMorgan
ChaseMorgan Stanley
Lehman Bros. U.S. Bank Wells Fargo
Long Term Debt Rating
Parent Rating A-/Baa2 A+/Aa3 A-/A3 A/A2 A-/Baa1 A+/Aa3 A+/A2
Bank Rating A/A3 AA-/Aa1 A /A2 A+/Aa3 A/A3 AA-/Aa2 AA-/Aa3
Debt Exposure
Swap Counterparty $50 million $50 million
Bond Trustee X
Line of Credit $100 million $50 million $100 million
Liquidity and Letters of Credit
Remarketing Agent$300 million
CP (1/2)$300 million
CP (1/2)$78 million
2003A
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Treasury Relationship Matrix
Bank of America/
Merrill Lynch
Bank of New York/
MellonGoldman
SachsJPMorgan
ChaseMorgan Stanley
SunTrust Bank U.S. Bank Wells Fargo
Cash and Investments Deposit Accounts X Savings Accounts Repurchase Agreements Money Market Funds Commercial Paper and Corporate Notes Foundation Endowment
Security Custody$300 million
Portfolio
5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments (Pre-2008)
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Treasury Relationship Matrix
Bank of America/
Merrill Lynch
Bank of New York/
MellonGoldman
SachsJPMorgan
ChaseMorgan Stanley
SunTrust Bank U.S. Bank Wells Fargo
Cash and Investments Deposit Accounts X Savings Accounts Repurchase Agreements Money Market Funds * $390,000 $640,000 $540,000 Commercial Paper and Corporate Notes Foundation Endowment
Security Custody$200 million
Portfolio
$100 million Portfolio & PFM Funds
5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments
* Pro-Rata Share of Mutual Fund Holdings
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Treasury Relationship Matrix
Bank of America/
Merrill Lynch
Bank of New York/
MellonGoldman
SachsJPMorgan
ChaseMorgan Stanley
SunTrust Bank U.S. Bank Wells Fargo
Operations
Banking Services X
Payroll Card X
Merchant Card X X Travel & Entertainment Card X
Integrated Payables X
On Grounds Branch/ATM X X X
5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Operations (Pre-2008)
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U.Va – What Next?
• Diversify Operating Risks• Explore better ways to measure risk• Use risk register to prioritize work• Find natural areas of avoidance• Implement monitoring approach
QUESTIONS?
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Contact Information
Barbara Fava, PFM Asset Management favab@pfm.com
June Matte, Public Financial Managementmattej@pfm.com
Jim Matteo, University of Virginiajsm6y@virginia.edu
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PFM DisclosuresThe material presented by PFM Asset Management and Public Financial Management (PFM) is based on information obtained from sources generally believed to be reliable and available to the public, however PFM cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities.