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US Money Center Banks

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  • In 2002, your company’s associates produced net income of $9.25 billion on revenue of $35.1 billion, compared to $6.79 billion and $35.0 billion in 2001. While these are solid results taking into account continuing economic headwinds, we are highly focused on increasing revenue in 2003 as we pursue our long-term goal of 7% to 9% annual revenue growth. Earnings per share (EPS) were $5.91, shareholder value added (SVA) was $3.76 billion, and return on equity (ROE) was 19.4%; these results compared, respectively, to $4.18, $3.09 billion and 14.0% in 2001.
  • Factors that influence Merrill Lynch’s credit ratings include the credit rating agencies’ assessment of the general operating environment, relative positions in the markets in which Merrill Lynch The Corporate Risk Management (“CRM”) group, along with other control units, works to ensure that these risks are properly identified, monitored, and managed throughout Merrill Lynch.
  • Our corporate governance structure enables us to manage all major aspects of our business through an integrated planning and review process that includes strategic, financial, associate and risk planning. We derive our revenue from assuming and managing customer risk for profit. Through a robust governance structure, risk and return is evaluated to produce sustainable revenue, to reduce earnings volatility and increase shareholder value. Our business exposes us to four major risks: liquidity, credit, market and operational. Liquidity risk is the inability to accommodate liability maturities and withdrawals, fund asset growth and otherwise meet contractual obligations at reasonable market rates. Credit risk is the inability of a customer to meet its repayment or delivery obligations. Market risk is the fluctuation in asset values caused by changes in market prices and yields. Operational risk is the potential for loss resulting from events involving people, processes, technology, legal issues, external events, execution, regulatory or reputation.
  • Our governance structure begins with our Board of Directors. The Board of Directors evaluates risk through the Chief Executive Officer (CEO) and three Board committees: • Finance Committee reviews market, credit, liquidity and operational risk • Asset Quality Committee reviews credit risk • Audit Committee reviews scope and coverage of external and corporate audit activities
  • Three Lines of Defense Management has established control processes and procedures to align risk-taking and risk management throughout our organization. These control processes and procedures are designed around “three lines of defense”: lines of business; Risk Management joined by other units such as Finance and Legal; and Corporate Audit. The lines of business are responsible for identifying, quantifying, mitigating and managing all risks. Except for trading-related business activities within Global Corporate Investment Banking , interest rate risk associated with our business activities is managed centrally in the Corporate Treasury function. Line of business management makes and executes the business plan, which puts it closest to the changing nature of risks and therefore best able to take actions to manage and mitigate those risks. Our management processes, structures and policies help us comply with laws and regulations and provide clear lines of sight for decision-making and accountability. Wherever practical, we attempt to house decision-making authority as close to the customer as possible. The Risk Management organization translates approved business plans into approved limits, approves requests for changes to those limits, approves transactions as appropriate and works closely with business units to establish and monitor risk parameters. Each of the four business segments has a Risk Executive assigned to it who is responsible for oversight for all risks of the line of business. Corporate Audit provides an independent assessment of our management systems and internal control systems. Corporate Audit activities are designed to provide reasonable assurance that resources are adequately protected; significant financial, managerial and operating information is complete, accurate, and reliable; and employees’ actions are in compliance with Corporate policies, standards, procedures, and applicable laws and regulations.
  • To ensure our risk management goals and objectives are accomplished, oversight of our risk-taking and risk management activities is conducted through three senior management committees. The Risk and Capital Committee (RCC) establishes long-term strategy and short-term operating plans. RCC also establishes the risk appetite through corporate performance measures, capital allocations, aggregate risk levels, and overall capital planning. RCC reviews actual performance to plan and actual risk incurred to forecasted risk levels, including information regarding credit, market and operational risk. The Asset and Liability Committee (ALCO), a subcommittee of the Finance Committee, reviews portfolio hedging used for managing liquidity, market and credit portfolio risks as well as interest rate risk inherent in our balance sheet and trading risk inherent in our customer and proprietary trading portfolio. ALCO approves Value at Risk (VAR) limits for various trading activities in the Corporation. The Credit Risk Committee (CRC) establishes corporate credit practices and limits, including industry and country concentration limits, approval requirements and exceptions. CRC also reviews business asset quality results versus plan, portfolio management, hedging results and the adequacy of the allowance for credit losses.
  • We use various controls to manage risks at the line of business level and corporate-wide. For example, our planning and forecasting process facilitates analysis of results versus plan and provides early indication of unplanned risk levels. Various line of business risk committees and forums are comprised of line personnel, Risk Management and other groups responsible for the internal control infrastructure (i.e. Finance, Legal, Compliance, Tax and/or Corporate Audit). Limits, the amount of exposure that may be taken in a product, relationship, region or industry, are set based on metrics thereby aligning our risk goals with those of each line of business. Models are used to estimate market and net interest income sensitivity. Modeling is used to estimate both expected and unexpected credit losses for each product and line of business. We employ hedging strategies to reduce concentrations and improve portfolio granularity and to manage interest rate risk in the portfolio. We have continued to strengthen the linkage between the associate performance management process and individual compensation to help associates work toward corporate wide goals. Finally, compliance plays a significant role in aiding our business units in risk management. Formal processes used in managing risk only represent one side of the equation. Corporate culture and the actions of our associates are critical to effective risk management. Through our recently updated Code of Ethics, we set a high standard for our associates. The Code of Ethics provides a framework for all of our associates to conduct themselves with the highest integrity in the delivery of their product or service to our customers.
  • In 2002, your company’s associates produced net income of $9.25 billion on revenue of $35.1 billion, compared to $6.79 billion and $35.0 billion in 2001. While these are solid results taking into account continuing economic headwinds, we are highly focused on increasing revenue in 2003 as we pursue our long-term goal of 7% to 9% annual revenue growth. Earnings per share (EPS) were $5.91, shareholder value added (SVA) was $3.76 billion, and return on equity (ROE) was 19.4%; these results compared, respectively, to $4.18, $3.09 billion and 14.0% in 2001.
  • Our corporate governance structure enables us to manage all major aspects of our business through an integrated planning and review process that includes strategic, financial, associate and risk planning. We derive our revenue from assuming and managing customer risk for profit. Through a robust governance structure, risk and return is evaluated to produce sustainable revenue, to reduce earnings volatility and increase shareholder value. Our business exposes us to four major risks: liquidity, credit, market and operational. Liquidity risk is the inability to accommodate liability maturities and withdrawals, fund asset growth and otherwise meet contractual obligations at reasonable market rates. Credit risk is the inability of a customer to meet its repayment or delivery obligations. Market risk is the fluctuation in asset values caused by changes in market prices and yields. Operational risk is the potential for loss resulting from events involving people, processes, technology, legal issues, external events, execution, regulatory or reputation.
  • Our governance structure begins with our Board of Directors. The Board of Directors evaluates risk through the Chief Executive Officer (CEO) and three Board committees: • Finance Committee reviews market, credit, liquidity and operational risk • Asset Quality Committee reviews credit risk • Audit Committee reviews scope and coverage of external and corporate audit activities
  • Three Lines of Defense Management has established control processes and procedures to align risk-taking and risk management throughout our organization. These control processes and procedures are designed around “three lines of defense”: lines of business; Risk Management joined by other units such as Finance and Legal; and Corporate Audit. The lines of business are responsible for identifying, quantifying, mitigating and managing all risks. Except for trading-related business activities within Global Corporate Investment Banking , interest rate risk associated with our business activities is managed centrally in the Corporate Treasury function. Line of business management makes and executes the business plan, which puts it closest to the changing nature of risks and therefore best able to take actions to manage and mitigate those risks. Our management processes, structures and policies help us comply with laws and regulations and provide clear lines of sight for decision-making and accountability. Wherever practical, we attempt to house decision-making authority as close to the customer as possible. The Risk Management organization translates approved business plans into approved limits, approves requests for changes to those limits, approves transactions as appropriate and works closely with business units to establish and monitor risk parameters. Each of the four business segments has a Risk Executive assigned to it who is responsible for oversight for all risks of the line of business. Corporate Audit provides an independent assessment of our management systems and internal control systems. Corporate Audit activities are designed to provide reasonable assurance that resources are adequately protected; significant financial, managerial and operating information is complete, accurate, and reliable; and employees’ actions are in compliance with Corporate policies, standards, procedures, and applicable laws and regulations.
  • To ensure our risk management goals and objectives are accomplished, oversight of our risk-taking and risk management activities is conducted through three senior management committees. The Risk and Capital Committee (RCC) establishes long-term strategy and short-term operating plans. RCC also establishes the risk appetite through corporate performance measures, capital allocations, aggregate risk levels, and overall capital planning. RCC reviews actual performance to plan and actual risk incurred to forecasted risk levels, including information regarding credit, market and operational risk. The Asset and Liability Committee (ALCO), a subcommittee of the Finance Committee, reviews portfolio hedging used for managing liquidity, market and credit portfolio risks as well as interest rate risk inherent in our balance sheet and trading risk inherent in our customer and proprietary trading portfolio. ALCO approves Value at Risk (VAR) limits for various trading activities in the Corporation. The Credit Risk Committee (CRC) establishes corporate credit practices and limits, including industry and country concentration limits, approval requirements and exceptions. CRC also reviews business asset quality results versus plan, portfolio management, hedging results and the adequacy of the allowance for credit losses.
  • Our primary business activities allow us to obtain funds from our customers in many ways and require us to provide funds to our customers in many different forms.
  • ALCO: In order to remain in the target range, management uses the Time to Required Funding measurement to determine the timing and extent of future debt issuances and other actions.
  • Borrowing costs and ability to raise funds are directly impacted by our credit ratings and changes thereto. The credit ratings of the Corporation and Bank of America, N.A. are reflected in the table below.
  • In addition, in connection with our balance sheet management activities, from time to time we may retain mortgage loans originated as well as purchase and sell loans based on our assessment of new market conditions.
  • Our core deposits were up seven percent from a year ago. The increase was due to significant growth in net checking accounts, increased money market accounts due to an emphasis on total relationship balances and customer preference for stable investments in these uncertain economic times. The decline in consumer CDs and IRAs was primarily driven by a change in product mix to money market and other deposit accounts.
  • Financial accounting standards board we will have to consolidate our multi-seller asset backed conduits beginning in the third quarter of 2003, as required by the rule. The new rule requires that for entities to be consolidated that those assets be initially recorded at their carrying amounts at the date the requirements of the new rule first apply.
  • Share issuing
  • based on an analysis of the borrower’s financial position in conjunction with current industry and economic or geopolitical trends.
  • to determine if any credit exposure should be placed on nonperforming status. An asset is placed on nonperforming status when it is determined that principal and interest are not expected to be fully collected It is difficult to predict the timing of such event risk and as a consequence the timing and amount of loss potential is more difficult to estimate.
  • monitored the interest rate risk position of the portfolio and repositioned the securities portfolio. Through sales of the securities portfolio, we realized $630 million in gains on sales of securities during the year. During the same period, we sold $22.7 billion of whole mortgage loans and recognized $500 million in gains on the sales. We use derivatives as an efficient, low-cost tool to manage our interest rate risk. Our interest rate contracts are generally non-leveraged generic interest rate and basis swaps, options, futures and forwards. The Corporation adopted SFAS 133 on January 1, 2001. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value
  • four business segment risk executives that are responsible for oversight of all operational risks in the business segments they support. In their management of these specific risks, they utilize corporate-wide operational risk policies, processes, and assessments. have our Corporate Audit group perform independent assessments of vendor management processes and key vendor processes, the latter including on-site work at our more significant vendors.
  • Transcript

    • 1. Risk Management of U.S. Money Center Banks Presented by: Wei Chen Bridge Hu Eric Song Jing Zhang Yuan Su Zhi
    • 2. Agenda
      • Industry Overview
      • Market Dynamics
      • Risk Management Environment
      • JP Morgan Chase
      • Merrill Lynch
      • Bank of America
      • Recommendation
    • 3. Definition of Money Center Bank
      • Money center bank : a large bank in a major financial center which borrows from and lends to governments, corporations, and other banks, rather than consumers
      • Market maker : a brokerage or bank that maintains a firm bid and ask price in a given security by standing ready, willing, and able to buy or sell at publicly quoted prices (from their own accounts)
    • 4. Products and Services
      • Personal banking
      • Business banking
      • Investment banking – advisory, debt and equity underwriting, market making, trading and investing of debts and equities
      • Treasury and Securities Services – cash management, institutional trust services, treasury services, clearing services
      • Investment management and private banking
      • Private equity – venture capital
    • 5. Market Dynamics
      • Global money center banks
      • market capitalization = 1,221B
      • ROE = 16.9%
      • Merrill Lynch (56B)
      47B Bank One 52B US Bankcorp 61B Wachovia 73B JP Morgan Chase 95B Wells Fargo 114B Bank of America 246B Citigroup Market Capitalization U.S. Money Center Banks
    • 6. Important Regulations
      • The Securities Exchange Act - established the Securities and Exchange Commission (SEC) as the primary regulator of US securities markets, including investment banks as well as non-banks that broker and/or deal non-exempt securities
      • Financial Services Competition Act in 1999 permitted commercial banks to have affiliated securities firms
      • Bank of International Settlements - Basel Capital Accord
      • Financial Accounting Standards Board – FASB Statement 133
    • 7. Basel Committee
      • Basel Committee
      • The Committee's members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States
      • Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank.
      • The Committee does not possess any formal supranational supervisory authority
      • It formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements - statutory or otherwise - which are best suited to their own national systems
    • 8. FAS 133
      • Accounting for Derivative Instruments and Hedging Activities (1998)
      • Result: substantially enhanced information about derivatives positions is now available in annual reports
      • FAS 133 has been amended twice already, by FAS 137 and FAS 138
    • 9. The Major Risks Banks Face
      • Liquidity risk
      • Interest risk
      • Market risk
      • Credit risk
      • Off-balance sheet risk
      • Foreign exchange risk
      • Operating risk
    • 10. Liquidity Risk
      • Definition: risk of not be able to honor bank’s financial commitments promptly
      • It arises from an uncertainty of the timing of cash flows
          • Liability-side risk results from unexpectedly high rates of deposit redemption
          • Asset-side risk results from borrowers unexpectedly drawing down loan commitment
    • 11. Liquidity Risk
      • Useful measurements
          • The net liquidity position, which measures sources and uses of liquidity
          • Peer group financial ratios
          • The financing gap, which show the degree to which loans are not financed by core fund
    • 12. Liquidity Risk Management
      • The fundamental dilemma of liquidity risk management
          • low yield of reserve assets
          • Liquidating investment
    • 13. Liquidity Risk Management
      • Liquidity risk management is carried
      • out at both the retail and wholesale
      • level
          • Demand deposit
          • Term deposit
          • Purchased money
          • Interbank borrowing
          • Repos
    • 14. Interest Risk
      • Definition: is the impact on banks earnings and market value of equity of changes in interest rates
          • Refinancing risk
          • Reinvestment risk
    • 15. Interest Risk (measurements)
      • Gap analysis
      • Duration analysis
      • Simulation model
    • 16. Interest Risk Management
      • Matching average life of assets and liabilities reduces interest rate risk, but it is not perfect hedge
      • Immunization requires dynamic rebalancing of the portfolio, which may be costly
      • To immunize the equity, set the leverage adjusted duration gap to zero
    • 17. Market Risk
      • Definition : the risk of bank losses from movement of market prices on its trading inventory
    • 18. Market Risk Measurement
      • Two ways to measure
          • Value-at-cost models (VAR)
          • The BIS standardized measurement method
    • 19. Credit Risk
      • Definition : the risk of loss due to the failure of a borrower, endorser, guarantor or counterparty to repay a loan or honor another predetermined financial obligation
    • 20. Credit Risk Measurement
      • Traditional approach
      • Quantitative approach
    • 21. Credit Risk Management
      • Available collaterals
      • Customers creditworthiness
    • 22. Off-balance Sheet Risk
      • Definition of off-balance sheet activities: activities that do not appear on the current balance sheet because it does not concern holding a currency primary claim(asset) or issuing a current secondary(liability)
      • Two categories: 1) Credit substitutes
      • 2) Derivatives
    • 23. Foreign Exchange Risk
      • The potential adverse impact on a bank’s earning and value of its equity from foreign exchange rate movement 
    • 24. Operating Risk
      • It is business risk which includes organizational behavior, technological systems and legal aspects of managing a bank
    • 25.  
    • 26. About JP Morgan Chase
      • Leading global financial services firm with operations in more than 50 countries
      • The merger of The Chase Manhattan Corporation and J.P. Morgan & Co. Incorporated was completed in December 2000
      • Assets of $793 billion; component of DJIA
      • No. 1 in global syndicated loans and asset backed securities
      • No. 1 private bank in the U.S.
      • No. 5 in global M&A
      • No. 1 in U.S. dollar clearing and commercial payments
      • No. 4 originator of residential mortgage loans in the U.S.
      • Fourth largest domestic credit card issuer
    • 27. Industry Standing
    • 28. Five Business Segments
      • Investment Bank
      • Investment Management & Private banking
      • Treasury & Securities Services
      • JPMorgan Partners
      • Chase Financial Services
    • 29. Two Brands
      • JPMorgan
      • Investment bank, research, private equity, treasury and securities services, asset management, private banking
      • Chase
      • Auto loans, checking, credit cards, education loans, home equity, investments, mortgage, online services, savings, insurance
    • 30. Revenue Structure
      • Business segment: 44% of total revenue from fixed income capital markets
      • Client segment: 50% of total revenue from financial institutions
      • Geographic region: 59% of total revenue from North America
    • 31. Revenue Structure
    • 32. Risk Management Structure
      • Risk Policy Committee of Board of Directors – oversees risk management
      • Capital Committee – deal with firm-wide capital planning, internal capital allocation, and liquidity management
      • Risk Management Committee – deal with credit risk, market risk, operational risk, private equity risk, and fiduciary risk
    • 33. Risk Management Structure
    • 34. Capital Management
      • Economic risk capital : assess capital adequacy utilizing internal risk methodologies
      • The methodology quantifies credit, market, and operating risk (and private equity risk for its private equity business) for each business, and assigns capital accordingly
    • 35. Liquidity Management
      • Utilize liquidity monitoring tools through normal and stress periods
      • Analytics rely on management’s judgment about ability to liquidate assets or use them as collateral for borrowings
      • Three primary measures of liquidity: holding company short-term surplus, cash capital surplus, and basic surplus
      • Derivatives: enter into derivative contracts to swap fixed-rate debt to floating-rate obligations and vice versa
      • Funding plan: use a variety of both short-term and long-term instruments (including deposits, federal funds purchased, repurchase agreements, commercial paper, bank notes, medium- and long-term debt, capital securities and stockholders’ equity)
    • 36. Credit Ratings for Funding Plan
    • 37. Off-balance Sheet Arrangements
      • Report off-balance sheet obligations and commitments
      • Special-purpose entities (or special-purpose vehicles)
      • SPE involves a company selling assets to the SPE, which funds the purchase by selling securities to investors
      • Critical to markets such as mortgage-backed securities, asset-backed securities, and commercial paper
    • 38. Off Balance-sheet Obligations and Commitments
    • 39. Credit Risk Management
      • Ensure that credit risks are accurately assessed, properly approved, continually monitored and actively managed
      • Assess on- or off-balance sheet exposures including loans, derivative receivables and lending-related commitments
      • To measure these risks, estimates are made of both expected and unexpected losses for each segment of the portfolio using statistical techniques
      • Two functions: Credit Risk Policy and Global Credit Management
    • 40. Credit Risk Policy
      • Formulate credit policies, limits, allowance adequacy and guidelines
      • Independent from the groups that approve and support credit activities
      • Manage problem credits
    • 41. Global Credit Management
      • Three functions: Credit Risk Management , Corporate Banking , and the Credit Portfolio Group
      • The first two participate in client coverage, are responsible for approving and monitoring all credit exposures
      • The last one manages the firm’s credit exposures resulting from both traditional lending and derivative trading activities
    • 42. Credit Portfolio
    • 43. Commercial Portfolio
    • 44.  
    • 45. Consumer Portfolio
    • 46.  
    • 47. Credit Management in Derivatives
      • Use the same credit risk management procedures to assess and approve potential credit exposures when entering into derivative transactions as those used for traditional lending
      • Use mark-to-market value of the contract, or the cost to replace the contracts at current market rates should the counterparty default, to measure credit risk exposure
      • Dynamic management: adjust and rebalance hedges as market conditions change, such as counterparty’s credit quality
    • 48. Mark-to-market Fair Value of Derivative Contracts
    • 49. Risk Profile of Derivative Receivables
    • 50. Use of Credit Derivatives
    • 51. Allowance for Credit Losses
      • Intended to cover probable credit losses
      • The Risk Management Committee reviews the allowance for credit losses relative to the risk profile of the firm’s credit portfolio and current economic conditions, and adjusts it accordingly
    • 52. Summary of Allowance and Provision for Credit Losses
    • 53. Market Risk Management
      • Corporate function: identify, measure, monitor and control market risk
      • Seek to facilitate efficient risk/return decisions and to reduce volatility in operating performance
      • Individual coverage teams are assigned to particular businesses where they have expertise in the specific types of risk
    • 54. Market Risk Measurement
      • Statistical risk measures:
      • Value-at-Risk (VAR)
      • Risk identification for large exposures (RIFLE)
      • Nonstatistical risk measures:
      • Economic value stress tests
      • Net interest income stress tests
      • Other measures of position size and sensitivity to market moves
    • 55. Value-at-Risk
      • Measure the dollar amount of potential loss from adverse market moves in an ordinary market environment
      • Used to compare risks across businesses, to monitor limits and to allocate economic capital
      • Back-testing of VAR against actual financial results to evaluate the soundness of the model
      • Stress-testing : capture exposure to unlikely but plausible events in abnormal markets (VAR – loss due to unlikely events in normal markets)
      • VAR and stress-testing are important determinants in capital allocation for market risk
    • 56. Value-at-Risk: Aggregate Portfolio
    • 57. Daily Market Risk-related Losses VS. VAR
    • 58. Market Risk Monitoring and Control
      • Limits – examine factors such as market volatility, product liquidity, business track record, and management
      • Qualitative risk management – review business strategy, market conditions, product details and effectiveness of risk controls
      • Model review – review risk models to assess appropriateness and consistency across businesses
      • Policies and procedures – specify a clear set of objectives, responsibilities, and procedures
    • 59. Operational Risk Management
      • Maintain a system of comprehensive policies and a control framework designed to provide a sound and well-controlled operational environment
      • Reputational risk : during 2002, the firm put in place an additional structure to take account of the potential for adverse reputational impact of transactions with clients, especially complex derivatives and structured finance transactions
    • 60. Operational Risk Management Practices
      • Governance structure
      • Operational risk policies and procedures
      • Operational Risk Committee
      • Business Control Committees
      • Self-assessment process
      • Focused on business-specific key risks and controls
      • Automated using Horizon software application
      • Develop and monitor action plans
      • Operational risk event monitoring
      • Internal error and loss data reported and analyzed to determine causal effects
      • Enables comparative analysis with external data
      • Alignment with internal audit activities
      • New capital allocation methodology (2003 Implementation)
    • 61. Merrill Lynch
    • 62. Company Overview
      • Merrill Lynch:
      • One of the world's leading financial management and advisory companies, with offices in 36 countries and private client assets of approximately $1.1 trillion. As an investment bank, it is a leading global underwriter of debt and equity securities and strategic advisor to corporations, governments, institutions and individuals worldwide. Through Merrill Lynch Investment Managers, the company is one of the world's largest managers of financial assets.
    • 63. Risk Management Philosophy
      • Risk-taking is an integral part of Merrill Lynch’s core business activities.
      • In the course of conducting its business operations, Merrill Lynch is exposed to a variety of risks including market, credit, liquidity, operational, and other risks that are material and require comprehensive controls and ongoing management.
      • The Corporate Risk Management (“CRM”) group, along with other control units, works to ensure that these risks are properly identified, monitored, and managed throughout Merrill Lynch.
    • 64. Corporate Risk Management Process
      • A formal risk governance organization that defines the oversight process and its components
      • A regular review of the entire risk management process by the Audit Committee of the Board of Directors
      • Clearly defined risk management policies and procedures supported by a rigorous analytical framework;
    • 65. Corporate Risk Management Process - cont
      • Communication and coordination between the business, executive, and risk functions while maintaining strict segregation of responsibilities, controls, and oversight
      • Clearly articulated risk tolerance levels as defined by a group composed of executive management (“the Management Group”) which are regularly reviewed to ensure that Merrill Lynch’s risk-taking is consistent with its business strategy, capital structure, and current and anticipated market conditions.
    • 66. Risk Governance Structure
      • Merrill Lynch’s risk governance structure is comprised of the Audit Committee , the Management Group , the Risk Oversight Committee (“ ROC ”), the business units , CRM , and various corporate governance committees .
    • 67. Risk Governance Structure
      • The Audit Committee
      • The Management Group
      • The ROC
      • Various other governance committees
    • 68. Corporate Risk Management
      • CRM is an independent control function responsible for Merrill Lynch’s market and credit risk management processes both within and across the firm’s business units
      • The co-heads of Risk management joined by other units such as Finance and Legal Corporate Audit
    • 69.  
    • 70. Risks
      • Market risk
      • Credit risk
      • Operational risk
      • Liquidity risk
    • 71. Market Risk (VaR)
      • Trading
    • 72. Market Risk (VaR)
      • Non-trading
    • 73. Credit Risk Management
      • CRM’s Credit Risk Group assesses the creditworthiness
      • Credit risk mitigation techniques include the right to require initial collateral or margin, the right to terminate transactions or obtain collateral should unfavorable events occur, the right to call for collateral when certain exposure thresholds are exceeded, and the purchase of credit default protection.
    • 74. Credit Risk Management
      • Merrill Lynch enters into International Swaps and Derivatives Association, Inc. master agreements or their equivalent (“master netting agreements”) with substantially all of its derivative counterparties as soon as possible. The agreements are negotiated with each counterparty and are complex in nature.
    • 75. Credit Risk Management
      • In addition, to reduce default risk, Merrill Lynch requires collateral, principally cash and U.S. Government and agency securities, on certain derivative transactions.
      • To further mitigate its default risk on derivatives whenever possible by entering into transactions with provisions that enable Merrill Lynch to terminate or reset the terms of its derivative contracts.
    • 76.
      • Credit exposure from derivative transactions
      Credit Risk Management
    • 77. Operational Risk
      • Maintaining a comprehensive system of internal controls
      • Using technology to automate processes and reduce manual errors, monitoring risk events,
      • Employing experienced personnel
    • 78. Operational Risk - cont
      • Monitoring business activities by compliance professionals
      • Maintaining fully operational, off-site backup facilities, conducting internal audits, requiring education
      • Training of employees, and emphasizing the importance of management oversight.
    • 79. Liquidity Risks
      • Liquidity risks include both being unable to raise funding with appropriate maturity and interest rate characteristics or being unable to liquidate an asset in a timely manner at a reasonable price.
    • 80.  
    • 81. Liquidity Risks Management
      • Maintain appropriate mix of short- and long-term capital
      • Maintain sufficient alternative funding sources
      • Concentrate unsecured financing at ML & Co.
      • Diversify unsecured funding sources
      • Adhere to prudent governance processes
    • 82. Non-Investment Grade Holdings and Highly Leveraged Transactions (high-risk assets)
      • Non-investment grade holdings have been defined as debt and preferred equity securities rated as BB+ or lower or equivalent ratings by recognized credit rating agencies, sovereign debt in emerging markets, amounts due under derivative contracts from non-investment grade counterparties, and other instruments that, in the opinion of management, are non-investment grade.
    • 83. Trading Exposures
    • 84. Non-Trading Exposures
    • 85. Valuation of Financial Instruments
      • Fair values for exchange traded securities and certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices.
    • 86. Valuation of Financial Instruments - cont
      • Fair values for OTC derivative financial instruments, which represent amounts estimated to be received from or paid to a third party in settlement of these instruments, are valued using pricing models based on the NPV of estimated future cash flows, and directly observed prices from exchange-traded derivatives, other OTC trades, or external pricing services.
    • 87. Categorized Assets
      • Highly liquid cash and derivative instruments for which quoted market prices are readily available
      • Liquid instruments
      • Less liquid instruments that are priced using management’s best estimate of fair value, and instruments which are valued using a model, where either the inputs to the model and/or the models themselves require significant judgment by management
    • 88.  
    • 89. Special Purpose Entities (“SPEs”)
      • SPEs are trusts, partnerships, or corporations established for a particular limited purpose. Merrill Lynch engages in transactions with SPEs for a variety of reasons. Many of these SPEs are used to facilitate the securitization of client assets whereby mortgages, loans or other assets owned by clients are transformed into securities (“securitized”).
    • 90.  
    • 91. Company Overview
      • No. 2 in U.S. in terms of revenues
      • No. 2 in U.S. in terms of assets
      • No. 3 debt arranger (underwriter) of global loans, international bonds, and medium-term notes.
      • More than 100,000 Bank of America associates provide financial products, services
    • 92. Cont’d
      • Their consumer and commercial banking operations serve more than one in four households in the United States
      • Bank of America is U.S.’s No. 1 small business lender
      • Bank of America Investment Services Inc., offers more than 820,000 account holders for wealth management
    • 93.  
    • 94. Risk Management Overview
      • Corporate Governance Structure
      • -Liquidity
      • -Credit
      • -Market
      • -Operational
    • 95. Governance Structure
      • Begins with Board of Directors. The Board of Directors evaluates risk through the Chief Executive Officer (CEO) and three Board committees:
      • - Finance Committee reviews market, credit, liquidity and operational risk
      • -Asset Quality Committee reviews credit risk
      • -Audit Committee reviews scope and coverage of external and corporate audit activities
    • 96. Three Lines of Defense
      • Lines of business
      • Risk management joined by other units such as Finance and Legal
      • Corporate Audit
    • 97. Senior Management Committees
      • The Risk and Capital Committee (RCC)
      • The Asset and Liability Committee (ALCO)
      • The Credit Risk Committee (CRC)
    • 98. Liquidity Risk Management
    • 99.
      • Two primary levels:
      • -parent company
      • -banking subsidiaries
      • Finance Committee is responsible for establishing the liquidity policy as well as approving operating and contingency procedures and monitoring liquidity on an ongoing basis
    • 100.
      • Parent company:
      • - Source: dividends received from its banking subsidiaries and proceeds from the issuance of senior and subordinated debt, commercial paper and equity
      • -Uses: repayment of maturing debt and commercial paper, share repurchases,dividends paid to shareholders and subsidiary funding.
      • Primary measure: Time to required funding
    • 101.
      • Banking subsidiaries :
      • - Source: customer deposits, wholesale funding and asset securitizations and sales
      • -Uses: repayment of maturing obligations and growth in the core and discretionary asset portfolios, including loan demand. Discretionary portfolio consists of securities, certain residential mortgages held for asset and liability management purposes, and our swap portfolio
      • ALCO regularly reviews the funding plan for the banking subsidiaries and focuses on maintaining prudent levels of wholesale borrowing
    • 102. Credit Rating
    • 103. Balance Sheet
    • 104. Deposits and Other funding Sources
    • 105. Off-Balance Sheet Financing Entities
      • Facilitate customers’ access to the commercial paper markets
      • Receive fees for providing combinations of liquidity, standby letters of credit (SBLCs) or similar loss protection commitments, and derivatives to the commercial paper financing entities
      • In January 2003, the FASB issued a new rule that addresses off-balance sheet financing entities
    • 106. Capital Management
      • Shares issued under employee plans and unrealized gains on securities
      • These increases were offset by share repurchases and dividends paid
      • On October 23, 2002, the Board approved a $0.04 per share, or seven percent, increase in the quarterly common dividend.
    • 107. Credit Risk Management
    • 108.
      • Commercial Portfolio Credit Risk Management
      • -Assessment of the credit risk profile of an individual borrower
      • -Risk rating
      • Consumer Portfolio Credit Risk Management
      • -Statistical techniques are used
      • -Statistical models are built using detailed behavioral and demographic information
    • 109. Outstanding Loans and Leases
    • 110. Nonperforming Assets and Net Charge-offs
      • Routinely review the loan and lease portfolio
      • These losses resulted from a multitude of factors:business failures as a result of financial reporting fraud, the prolonged weak economic environment and industry specific issues.
    • 111. Nonperforming Assets
    • 112. Nonperforming Assets Activity
    • 113.
      • Conduct periodic and systematic detailed reviews
      • The allowance for credit losses represents management’s estimate of probable losses in the portfolio
      Allowance for Credit Losses
    • 114. Problem Loan Management
      • Assist borrowing companies in refinancing with other lenders or through the capital markets
      • Facilitate the sale of entire borrowing companies or certain assets/subsidiaries
      • -selling individual assets in the secondary market
    • 115. Market Risk Management
    • 116. Trading Risk Management
      • Trading account assets and liabilities
      • Derivative positions
      • Mortgage banking assets
    • 117. Trading Activities Market Risk
    • 118. Interest Rate Risk Management
      • Goal: to manage interest rate sensitivity so that movements in interest rates do not adversely affect net interest income
      • What involved: securities,r esidential mortgage portfolio, Securities
    • 119. Techniques
      • Complex sensitivity simulations are used to estimate the impact
      • The Balance Sheet Management division maintains a net interest Income forecast utilizing different rate scenarios
      • The overall interest rate risk position and strategies are reviewed on an ongoing basis with ALCO and other committees as appropriate
    • 120. Operational Risk Management
    • 121. Techniques
      • Corporate wide or business segment specific policies and procedures, controls and monitoring tools.e.g. personnel management practices, data reconciliation processes, fraud management units, transaction processing monitoring and analysis, systems interruptions and new product introduction processes
      • Company-wide quarterly self-assessment process
      • Identify key risk indicators
    • 122. Structure  
    • 123. Recommendations
      • Disclose more detailed information on specific derivative instruments used in risk management
      • Generally well established risk management models for each institution given respective risk management philosophies