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Transcript of Balance Sheet Risk Management
M A R C H 2 0 0 8
C R E A T I N G S U P E R I O R B A L A N C E S H E E T R I S K M A N A G E M E N T S O L U T I O N S
2008 EACUBO Annual Workshop
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English_General
This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. JPMorgan’s opinions and estimates constitute JPMorgan’s judgment and should be regarded as indicative, preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.
Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company by JPMorgan.
JPMorgan’s policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.
IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters included herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone not affiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by a combination of J.P. Morgan Securities Inc., J.P. Morgan plc, J.P. Morgan Securities Ltd. and the appropriately licensed subsidiaries of JPMorgan Chase & Co. in Asia-Pacific, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank, N.A. JPMorgan deal team members may be employees of any of the foregoing entities.
This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange credit or to provide any other services.
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Treasury Management at University of Pennsylvania
Internal Bank Management at University of Virginia
Overview of Risk Management Principles
Introduction
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Today’s panelists
Helen Kreider, University of Pennsylvania
INSERT BRIEF BIO
Jim Matteo, University of Virginia
Director of Treasury Operations since August 2005, responsible for debt management, banking & cash management, investment portfolio oversight, liquidity & interest rate management
Charlie Giffin, JPMorgan
Co-Head of Issuer Solutions group within Tax Exempt Capital Markets, with specialty in enterprise risk management, market analytics, and integrated solutions across different markets
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What do we mean by “Balance Sheet Risk Management?”
Identify risk exposures Financing risks Investment risks Operational risks Construction risks
Quantify risk exposures (where possible) Expected outcome Volatility Correlation
Manage risk vs. return Accept appropriate amounts of risk Maximize net financial performance Anticipate “worst case” outcomes
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The danger of what we don’t yet know
“With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. …Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.”
- Alan Greenspan, April 5, 2005
“We are all wrong so often that it amazes me that we can have any conviction at all over the direction of things to come. But we must.”
- Jim Cramer, CNBC
“It's tough to make predictions, especially about the future.”
- Yogi Berra
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Treasury Management at University of Pennsylvania
Internal Bank Management at University of Virginia
Overview of Risk Management Principles
Introduction
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Much of risk management can be simplified to averages and standard deviations (volatility)
There are a number of common risk factors within investment management…
Investment Factors
Average Return Annual Volatility
S&P 500 7.50% 14.0%
Russell 2000 9.00% 18.0%
MSCI EAFE 10.00% 14.0%
Lehman Bros. Agg 6.00% 3.5%
US Treasury Bills 3.75% 0.5%
HFR FOF Strategic 8.00% 9.0%
HFR FOF Conserv 6.50% 3.5%
Yield Factors
Average Rate Annual Volatility
LIBOR 5.00% 25.0%
BMA 3.40% 25.0%
BMA/LIBOR 68.00% 9.0%
CPI 3.25% 40.0%
… as well as within debt management
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Correlations between risk factors is what drives the benefits of portfolio diversification
Correlation Matrix
LIBOR BMA/LIB 5Y LIB S&P 500 Russell 2000 MSCI EAFELehman
Agg T-BillsHFR FOF
AHFR FOF
B
LIBOR 1.00 (0.35) 0.65 0.06 0.01 0.20 (0.05) (0.02) 0.09 0.08
BMA/LIB (0.35) 1.00 (0.20) 0.07 (0.01) 0.00 0.08 0.01 (0.10) (0.07)
5Y LIB 0.65 (0.20) 1.00 0.24 0.23 0.20 (0.88) (0.09) 0.16 0.12
S&P 500 0.06 0.07 0.24 1.00 0.74 0.82 (0.22) (0.00) 0.57 0.46
Russell 2000 0.01 (0.01) 0.23 0.74 1.00 0.72 (0.18) (0.08) 0.77 0.56
MSCI EAFE 0.20 0.00 0.20 0.82 0.72 1.00 (0.20) (0.08) 0.67 0.58
Lehman Agg (0.05) 0.08 (0.88) (0.22) (0.18) (0.20) 1.00 0.10 (0.15) (0.12)
T-Bills (0.02) 0.01 (0.09) (0.00) (0.08) (0.08) 0.10 1.00 (0.03) 0.02
HFR FOF A 0.09 (0.10) 0.16 0.57 0.77 0.67 (0.15) (0.03) 1.00 0.89
HFR FOF B 0.08 (0.07) 0.12 0.46 0.56 0.58 (0.12) 0.02 0.89 1.00
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For investment portfolio management, the “efficient frontier” is a common representation of risk vs. return
Potential Investment Allocation Alternatives1Potential Investment Allocation Alternatives1
1 Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements on financial market trends, which are based on current market conditions. We believe the information provided herein is reliable, but it should not be assumed to be either accurate or complete. Actual cash flows may vary substantially from figures shown based upon changes in market condition, our judgment or the underlying assumptions or methodology employed. Past performance should not be taken as a guarantee of future results. Analysis includes assumptions for initial and average interest rates, correlations, volatility and reversion speed, among others. Volatility is defined here as standard deviation of annual changes in an exposure, and not necessarily a cross section of potential future cumulative outcomes.
Current Portfolio
Efficient Frontier of investment alternatives
Current Portfolio Allocation Balance
S&P 500 25,000,000
Russell 2000 25,000,000
MSCI EAFE 25,000,000
Lehman Bros. Agg 25,000,000
US Treasury Bills 200,000,000
HFR FOF Strategic 100,000,000
HFR FOF Conserv 100,000,000
Total 500,000,000
Institutions can choose an efficient portfolio of investment alternatives, subject to individual risk tolerance constraints
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Debt managers can benefit from adopting risk management principles developed through the investment community
Investment Management Debt Management
Sensitivity Total Return (Mark to Market)
Cost (Cash Flow)
Risk Measures Value at Risk (VaR); Price Volatility
Cash Flow at Risk (CFaR); Cost Volatility
Objective Maximize Return; Minimize Risk
Minimize Cost; Minimize Risk
Analytics Capture Correlations of Returns
Capture Correlations of Carry
Diversification Uncorrelated Sources of Return
Uncorrelated Sources of Carry
Market Constraints
Value at Risk Important
Both VaR and CFaR Important
Market Opportunities
Hedge Funds, Energy, Weather
BMA, LIBOR, CPI, CMS, ???
Investment Management Compared to Debt ManagementInvestment Management Compared to Debt Management
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We can also create an “efficient frontier” for various debt management strategies in the current market
Potential Investment Allocation Alternatives1Potential Investment Allocation Alternatives1
1 Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements on financial market trends, which are based on current market conditions. We believe the information provided herein is reliable, but it should not be assumed to be either accurate or complete. Actual cash flows may vary substantially from figures shown based upon changes in market condition, our judgment or the underlying assumptions or methodology employed. Past performance should not be taken as a guarantee of future results. Analysis includes assumptions for initial and average interest rates, correlations, volatility and reversion speed, among others. Volatility is defined here as standard deviation of annual changes in an exposure, and not necessarily a cross section of potential future cumulative outcomes.
Current Portfolio
Efficient Frontier of debt alternatives
Current Portfolio Allocation Balance
Fixed 150,000,000
% Libor Synthetic Fixed 150,000,000
Floating 100,000,000
BMA Basis Swap -
CMS Swap -
Total 400,000,000
Institutions can choose an efficient portfolio of debt instruments, again subject to individual risk tolerance constraints
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Finally, we can also incorporate operational exposures that are specific to each institution
Institutions have a number of potential operational risk exposures: Changes in top line revenue Changes in expenses Changes in Endowment distribution
Other potential sources of risk: Healthcare related income / expenses Royalties State contributions
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The Central Treasury function manages a number of different risks for the University
Internal Loans
Internal Deposits
Return: 4.5%Volatility:
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Cost: 5.0%Volatility:
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Capital Projects
Operations
$250mm
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External Assets
External Debt
Return: 6.5%Volatility:
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Cost: 4.25%Volatility:
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$500mm
$400mm
$350mm
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With this framework, institutions can choose an appropriate level of risk, and maximize related net returns
Potential Net Risk/Return Alternatives1Potential Net Risk/Return Alternatives1
Current Portfolio
Efficient Frontier of Central Treasury
1 Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements on financial market trends, which are based on current market conditions. We believe the information provided herein is reliable, but it should not be assumed to be either accurate or complete. Actual cash flows may vary substantially from figures shown based upon changes in market condition, our judgment or the underlying assumptions or methodology employed. Past performance should not be taken as a guarantee of future results. Analysis includes assumptions for initial and average interest rates, correlations, volatility and reversion speed, among others. Volatility is defined here as standard deviation of annual changes in an exposure, and not necessarily a cross section of potential future cumulative outcomes.
$354
$455
$556
$657
$758
$859
$960
$1,061
$1,162
$1,263
5Y Ending Balance
Current Solution
Ending Balance Distribution ($mm)Ending Balance Distribution ($mm)
Solution
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Better understanding of risk exposures leads to superior balance sheet risk management
Measures of annual risk exposure Annual external debt portfolio volatility of $4 million Annual external investment volatility of $22 million Annual net balance sheet volatility of $23 million
Size appropriate reserves 95% confidence level reserve: $55 million
Determine appropriate liquidity requirements A liquidity strategy is essential to anticipate sources of risk that
cannot be wholly quantified
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Treasury Management at University of Pennsylvania
Internal Bank Management at University of Virginia
Overview of Risk Management Principles
Introduction
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University of Virginia Overview
Public University Founded by Thomas Jefferson in 1819
Ranked #2 among public universities and #23 among all universities in U.S. News and World Report’s 2008 Rankings
Fall 2007 - 20,834 students enrolled in 10 Schools on Main Grounds
FY 2007 Financial Data Net Assets = $5.4b Total Revenue = $2.8b Debt Outstanding = $573m Endowment Value = $4.4b AAA ratings from Moody’s, S&P, and Fitch
Operates the University of Virginia Medical Center Recognized among Solucient’s Top 100 Hospitals every year since 1998 Responsible for 31% of University’s FY07 Total Revenue
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University of Virginia Treasury Department Overview
Debt Management Fixed and Variable Rate Bonds Commercial Paper Interest Rate Derivatives
Investment Management ST Investment Management Oversight of LT Investments in Endowment Oversight of Other Financial Assets (Securities, Trusts, etc.)
Cash Management Bank Account Management Cash Forecasting
Internal Bank Management Internal Loan Program Internal Investment Program Quasi-endowment Administration
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Dual Goals of Treasury
University-wide Goals Optimize risk/return profile for financial assets and liabilities Provide for sufficient liquidity Manage the cash flow volatility
Treasury Internal Bank Goals Manage Budgetary Volatility Manage Allocation of Financial Resources Manage Margins
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Internal Bank Model
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Internal Bank Net Cash Flow
Cash Forecasting
EXTERNAL FLOWS
INTERNAL FLOWS
Investments Activities
Financing Activities
Internal Financing Activities· Loan Programs
Internal Investment Interest Payments
Internal Investing Activities· Investment Programs
Internal Loan Interest Payments
Financing Interest
Payments
Investment Earnings
Liability
Liability
Revenue
Revenue Expense
Expense
Asset
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Scope of Identified Risk Exposures
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University-wide Internal Bank
Investment Activities
External Investments External Investments
Internal Loans to Units
Financing Activities
External Borrowing External Borrowing
Internal Investments by Units
Operating Activities
University Operating Cash Flow
University Non-Financial Capital Flows
Cash Flow Managed by Treasury
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Treasury Internal Bank Balance Sheet
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Assets
Cash 27,232
Short Term Investments 98,393
Internal Borrowing Program Receivable 321,521
Long Term Investments (LTP) 539,822
Total Assets 986,968
Liabilities
Short Term Debt - Commercial Paper and Other 84,900
Long Term Debt - Bonds 505,151
Bond Premium/Discount 17,779
Internal Investment Program (IIP) Deposits 358,859
Deposits Due To/(From) Departments (9,218)
Total Liabilities 957,471
Retained Earnings 29,868
Net Assets Designated to Budget Office (372)
Net Assets 29,496
Total Net Assets and Liabilities 986,968
Internal Bank Balance Sheet – December 31, 2007 ($000’s)Internal Bank Balance Sheet – December 31, 2007 ($000’s)
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Initial Internal Bank risk assessment
Internal Bank Risk Factors ($ in mm) – FYE 12/30Internal Bank Risk Factors ($ in mm) – FYE 12/30
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Pursuing the Efficient Frontier
Potential Internal Bank Alternatives1Potential Internal Bank Alternatives1
1 Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements on financial market trends, which are based on current market conditions. We believe the information provided herein is reliable, but it should not be assumed to be either accurate or complete. Actual cash flows may vary substantially from figures shown based upon changes in market condition, our judgment or the underlying assumptions or methodology employed. Past performance should not be taken as a guarantee of future results. Analysis includes assumptions for initial and average interest rates, correlations, volatility and reversion speed, among others. Volatility is defined here as standard deviation of annual changes in an exposure, and not necessarily a cross section of potential future cumulative outcomes.
UVA can choose a desirable risk level and implement changes to any number of the underlying risk factors External investments External debt Internal debt Internal deposits
Current Portfolio
Efficient Frontier of portfolio combinations
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Developing a Planning Horizon
INSERT
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Optimizing the Portfolio
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Next Steps on Balance Sheet Management
Education and Buy-in
Drawing from the Endowment Model
Making it manageable
Setting Priorities between External and Internal Goals
Implementation
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Treasury Management at University of Pennsylvania
Internal Bank Management at University of Virginia
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University overview & background
Academic Component 12 Schools
Health System 3 Hospitals 19 Clinical Practices
Revenues of $4.8 billion 55% Health System 15% Research; 13% Tuition; 6% Investment income; 10% Other
Expenses of $4.4 Billion 53% Health System 47% Academic
$7.3 Billion Investments $6.6 billion Endowment
$1.3 Billion Debt
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Overview of treasury structure
$705 Million Working Capital at December 31,2007 $340 Million money market investment
— Recent in depth review of all money market funds in conjunction with our Investment Office
$320 Million invested in the University’s endowment $45 Million in Stafford loans
$570 Million Debt $228 Million variable rate
— $123 Million in auction market— $62 Million in VRDO market— $43 Million in private placements, bank loans
$342 Million fixed rate debt
$200 Million Projected Borrowing Needs $100 Million forward starting fixed rate swap
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Management goals & objectives
Optimize investment return within acceptable risk parameters Primary object for working capital is preservation of capital Competitive real return
— Cash return (benchmarked at tbill) supports operating budget— Excess return funds a reserve and supports President’s initiatives
Stable return— Reserve fund created — Currently 5% of equity fund — Target 10% of equities
Optimize debt service cost within acceptable risk parameters Debt policy
— Consider the hedge between cash and variable debt— May choose to issue fixed rate in historically low environments to
preserve variable capacity Derivatives policy
— May be used to reduce costs or hedge exposures— Review broker exposures relative to market value of derivatives
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Scope of identified risk exposures
Investment activities Return volatility Call on cash from schools Capital expenditures
Financing activities Variable Rate exposure
— SIFMA vs LIBOR— Health System risk
Operational activities Business continuity
— Identified critical procedures— Contract for off campus facilities in emergency
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Sample analysis of alternative investment portfolios for working capital
Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements on financial market trends, which are based on current market conditions. We believe the information provided herein is reliable, but it should not be assumed to be either accurate or complete. Actual cash flows may vary substantially from figures shown based upon changes in market condition, our judgment or the underlying assumptions or methodology employed. Past performance should not be taken as a guarantee of future results.
Alternative Investment Analysis ($inMM)
Current Portfolio
More Endowment
More Fixed Income
More Alternatives
Cash 430 310 100 80
ML 1-3 - - 180 75
Lehman Agg - - 150 50
S&P 500 - - - -
Russell 2000 - - - -
HFR FOF Conserv. - - - 150
HFR FOF Strategic - - - 75
Penn Endowment 330 450 330 330
760 760 760 760
Expected Return 6.30% 7.15% 6.93% 7.59%
Volatility 3.63% 4.92% 4.02% 4.12%
Average Annual NFI 56.0 66.4 57.3 67.4
95% Worst Case NFI (38.0) (64.9) (47.0) (43.5)
95% NFI-at-Risk 94.0 131.3 104.3 110.8
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E A C U B O 2 0 0 8
In closing…
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