Credit Portfolio Business Model & Iacpm Introduction

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Credit Portfolio Business Model & Iacpm Introduction

  1. 1. -IACPM Introduction -CPM Business Models 2008
  2. 2. We cannot direct the wind but can adjust the sail. Restricted We don’t know when it will rain, but we know it will. ‘ ’ AGENDA OF TODAY •Introduce IACPM -- International Association of Credit Portfolio Managers •Why do banks need Credit Portfolio Management •Sound practices of CPM business models Copyright © 2007 ERIC KUO — Confidential 2
  3. 3. The International Association of Credit Portfolio Manager established in Restricted 2001 to further the practice of credit exposure management . IACPM 立 2001年, ’ ’. Who We Are and What We Are About •Established in 2001 . •Promote the practice of credit exposure management by providing an forum to exchange ideas on topics of common interest. •There are 87 financial institutions worldwide that are members of the IACPM… •..and from 14 countries and include many of the world’s largest commercial wholesale banks, investment banks and insurance companies, as well as a number of asset managers. •Represents its members before legislative and administrative bodies. •Conducts research on the credit portfolio management field. Copyright © 2007 ERIC KUO — Confidential 3
  4. 4. Restricted Many banks have participated in the portfolio management. DZ Bank National City Bank Aareal Bank Euler Hermes Group ABN AMRO Bank Natixis Export Development Canada Allianz AG Nationwide Insurance Fifth Third Bank Atradius NIBC Bank FirstRand Bank Australia and New Zealand Banking Group PB Capital Fortis Bank of America PNC 行 Bank of Ireland Primus Asset Management Goldman, Sachs HSBC Bank of Montreal RaboBank HSH Nordbank Bank of New York Mellon Royal Bank of Canada Hypovereinsbank Royal Bank of Scotland Bank of Tokyo-Mitsubishi UFJ IKB Deutsche Industriebank Barclays Capital Scotiabank ING Capital 行 SEB Bear Stearns Intesa Sanpaolo BNP Paribas Shinsei Bank JPMorgan Chase Bluecrest Capital Société Générale KBC Bank Standard Bank of South Africa BP KeyBank Calyon Standard Chartered KfW Capital One Sumitomo Mitsui Banking Corporation KfW IPEX-Bank CIBC World Markets SunTrust Banks Landesbank Baden Wurttemberg Citigroup Swiss Re Lloyds TSB Bank Citizens Financial Group TD Securities Manulife Financial Corporation Chinatrust Financial Holding TIAA-CREF 行 Commercial Industrial Finance Corp. UBS AG Merrill Lynch Commerzbank U.S. Bancorp MetLife Commonwealth Bank of Australia Wachovia Corporation Mizuho Corporate Bank Monte Dei Paschi Di Siena Credit Suisse Wells Fargo Bank 行 DEPFA Bank plc WestLB Morgan Stanley Deutsche Bank Westpac Banking Corporation Munich Reinsurance National Australia Bank Dexia SA WGZ Bank National Bank Financial Dresdner Kleinwort XL Capital Copyright © 2007 ERIC KUO — Confidential 4
  5. 5. We cannot direct the wind but can adjust the sail. Restricted We don’t know when it will rain, but we know it will. ’更 ‘ ‘ ’ AGENDA OF TODAY •Introduce IACPM -- International Association of Credit Portfolio Managers •Why do banks need Credit Portfolio Management •Sound practices of CPM business models Copyright © 2007 ERIC KUO — Confidential 5
  6. 6. Facing the same down-side risk but the up-side is totally different that Restricted 利力 makes the stock investment –a winner’s game. ’ ’ ’ ’ 利, 臨 .’ ’ ’ ’. Payoff comparison of stock and loan Return Stock With possibility of 不 ‘high’ return With high possibility of ‘constant’ return Loan 0 But faces the same down side loss with low possibility - 100 % Copyright © 2007 ERIC KUO — Confidential 6
  7. 7. Restricted The outcome of credit portfolio is asymmetric – A small number of bad loan wipe your capital out. 歷 . ’不 ’ The game of credit portfolio Probability of loss •Asymetric risk return pay-off. •Long tail and concentration – ‘Once in a blue moon’ is more common than we think. ‘Once in a blue moon’ rare happens but once it does , you are ‘Sayonara’ Remedy •Diversification Reserve Capital •Active portfolio management Potential “unexpected” Zero Expected Potential “unexpected” losses against which it losses level of loss losses for which capital would be too should be held expensive to hold capital Loss 0% 100% rate Copyright © 2007 ERIC KUO — Confidential 7
  8. 8. The definition of Portfolio management : Support the shift from Restricted ‘Originate & Hold’ to ‘Originate & Distribute’ – a new credit business model. 理’. CPM , ’ Illustrative Active credit portfolio management approach Traditional credit management Credit •Loan Management Origination Origination Trading Relationship Relationship •CDS Monitor Active Management Primary Management Workout •CDS Primary Secon- Credit Index dary Portfolio Market Market Manage- •CDO Market ment •ABS Credit Credit •Portfolio Approval / Approval / Rating Trading Rating Source : ERisk, Copyright © 2007 ERIC KUO — Confidential 8
  9. 9. We cannot direct the wind but can adjust the sail. Restricted We don’t know when it will rain, but we know it will. ’理 ‘ ’ ’ AGENDA OF TODAY •Introduce IACPM -- International Association of Credit Portfolio Managers •Why do banks need Credit Portfolio Management •Sound practices of CPM business models Copyright © 2007 ERIC KUO — Confidential 9
  10. 10. Restricted Mandates of ‘Credit Portfolio Management’ Function . 行 不 CPM , Common Mandates of CPM CPM unit may under.. •Analytical Function (We are here): •Business unit side Capital management ─ ─ Risk measurement Limit / Large exposure management ─ ─Portfolio Analysis Support business growth ─ Focus on ‘relationship’ and ‘Cross- ─Economic capital ─ selling’ ─Monitoring •Risk side A hedge budget is prerequisite Risk control ─ Hedge credit risk purely in the ‘Risk’ ─ ─ Reduce ‘Concentration risk’ perspectives Support business growth Solve ‘concentration’ , ‘tail’ risk ─ •Independent unit ─ Capital management Private side :Maximize Return / Minimize ─ Credit treasury Risk – Barclays bank Public side : Fund manager ‘s approach ─ Diversified portfolio through ─ – HVB Bank ‘invest in Credit’ Copyright © 2007 ERIC KUO — Confidential 10
  11. 11. LEMG Organisation at Deutsche Bank also belong to the BU side. Restricted DB is the winner of ‘Credit portfolio House of the Year in 2005’. 行 理’ 理’ 理’BU Side’ ’ ’ , . Asset is transferred based on either ‘Market price’ or 行 行 ‘Model’. If the CDS for a name in the market asks for 300 bps, but RM only ask for 100 bps , then RM needs to pay for the shortfall Credit risk Group Market risk Group Note: LEMG = Long Exposure Management Group. Copyright © 2007 ERIC KUO — Confidential 11
  12. 12. Restricted Implementation takes time and DB began from simple . 理 拓 Start with a subset of the total portfolio Start with assets most closely aligned to the mandate given to CPM; assets where CPM can create the most value Allow time to build the infrastructure, data bases, expertise required by the mandate Large Corporate Long-Term Book: Asia/Pacific Large Corporate Long-Term Book: Large Corporate Europe Short -Term Book Large Corporate German German Long-Term Book: Mid -Cap Book: Mid -Cap Book Short Term Long-Term North America 2006 2005 2003 2004 Copyright © 2007 ERIC KUO — Confidential 12
  13. 13. Restricted DB quotes an internal transfer price or “shortfall” for new loans, based on 參 capital markets benchmarks. CPM , , 不論 CDS 行’ ’ . Same Price Price for Market price / internal transfer value Business decision Credit and cost allocation approval Credit Loan Capital Manages credit risk Risk Screening Client strategy Markets Management Committee and loan origination Shortfall payment Loan Global Markets Exposure Transaction Loan assets Management Global Banking s with Group markets Residual P&L •Sponsoring business divisions pay shortfall and loan is transferred to LEMG •Sponsoring business divisions pay shortfall and loan is transferred to LEMG •Upfront Shortfall = Cost of Hedge -- Revenues Generated from the Loan •Upfront Shortfall = Cost of Hedge Revenues Generated from the Loan (based on current pricing and assumed utilization) (based on current pricing and assumed utilization) Source : Andrew Rothery , Head of LEMG, Asia Pacific . Copyright © 2007 ERIC KUO — Confidential 13
  14. 14. Restricted Mandates of ‘Credit Portfolio Management’ Function Common Mandates of CPM CPM unit may under.. •Business unit side •Analytical Function : Capital management ─ ─ Risk measurement Limit / Large exposure management ─ Support business growth ─ ─Portfolio Analysis Focus on ‘relationship’ and ‘Cross- ─ ─Monitoring selling’ •Risk side Risk control A hedge budget is pre-requisit ─ ─ Reduce ‘Concentration risk’ Hedge credit risk purely in the ‘Risk’ ─ perspectives Support business growth Solve ‘concentration’ , ‘tail’ risk ─ ─ Capital management •Independent unit Credit treasury Private side :Maximize Return / Minimize ─ Risk – Barclays bank ─ Diversified portfolio through Public side : Fund manager ‘s approach ‘invest in Credit’ ─ – HVB Bank Copyright © 2007 ERIC KUO — Confidential 14
  15. 15. PMU Organisation at Citigroup is separated, the ‘Public’ side responsible forRestricted the trading and cannot access to the internal information. The ‘Private’ side is under ‘Risk’ group and hedge credit risk with a budget. Chinese Wall Hedging Desk Trading Desk ORR不 漏 Public Trader 利 易 Copyright © 2007 ERIC KUO — Confidential 15
  16. 16. Restricted Mandates of ‘Credit Portfolio Management’ Function Common Mandates of CPM CPM unit may under.. •Business unit side •Analytical Function : Capital management ─ ─ Risk measurement Limit / Large exposure management ─ Support business growth ─ ─Portfolio Analysis Focus on ‘relationship’ and ‘Cross- ─ ─Monitoring selling’ •Risk side Risk control A hedge budget is pre-requisit ─ ─ Reduce ‘Concentration risk’ Hedge credit risk purely in the ‘Risk’ ─ perspectives Support business growth Solve ‘concentration’ , ‘tail’ risk ─ ─ Capital management •Independent unit – Bank Credit treasury Private side :Maximize Return / Minimize ─ Risk – Barclays bank ─ Diversified portfolio through Public side : Fund manager ‘s approach ‘invest in Credit’ ─ – HVB Bank Copyright © 2007 ERIC KUO — Confidential 16
  17. 17. Shinsei bank considers its IB strategy : a platform of providing lending, Restricted securitization, credit trading, capital market, advisory and asset management. Copyright © 2007 ERIC KUO — Confidential 17
  18. 18. Restricted Structured credit activities contribute 26% of total revenue. 金 來 2005年 , 26% ’ ’’ ’. Copyright © 2007 ERIC KUO — Confidential 18
  19. 19. CDS market in Japan grows at an exponential rate, even though the lendingRestricted , 歷了7年 易量 rate is at record low. CDS 金– 利率 ’2,713’ ’1.5%’ . 2001 ~ 2007 CDS Market Size –Japan 2007 CDS Market Breakdown – Japan Loan Rate – Japan v.s Taiwan Transaction focuses on the single name CDS in 2007 and Low lending rate is not an excuse for developing the accounts for 71% of total transaction. CDS market, on the contrary , it becomes a fuel ,motivation to hedge credit risk under the low interest In terms of tenor, 80% of volume concentrates on 1 to 5 Year rate environment in Japan. CDS. Lending rate(%) CDS Volume (Unit : US Billion ) Unit : US Million 300 8 271,383 271,383 271 43,118 6.49 Above 5 Year Taiwan Lending rate 76,669 Multi-Name CDS 6 Japan Lending rate 200 183 143 4 3.22 1~5 Year 218,968 194,713 100 Single name 2 1.46 1.48 31 25 18 14 9,296 1 Year CDS 0 0 Name Tenor 2001 2002 2003 2004 2005 2006 2007 Source: Bank of Japan. Figures show the notional amount of transaction on the Aug 2007. Lending rate represents for the Lending revenue rate instead of credit spread. Taiwan ‘s average loan rate is from 料, 行 2007年9 23.5 Billion 易量 Copyright © 2007 ERIC KUO — Confidential 19
  20. 20. The originator pays a subsidy if low return assets are written for relationship Restricted reasons. Moreover ,Barclays does not believe that good business has been lost due to the subsidy system. Copyright © 2007 ERIC KUO — Confidential 20
  21. 21. Restricted Barclays manage portfolio as a tradable securitization and change its weighting regularly. Copyright © 2007 ERIC KUO — Confidential 21
  22. 22. Restricted The common challenge is – There is not a credit market in Taiwan. 來 , ’First Mover’s Advantage’ . ..it all can be resolved if we want to. Usually Banks face the challenge.. •Market won’t grow by its own •Credit market is illiquid J.P Morgan is the first mover in CDS, back to 1997 when no ─ ─ CDS price is too high one knew what is CDS . Chinatrust bank can wait for the market matured or become the ─ ─ ‘Equity tranchee’ is hold by market maker in Taiwan. bank and cannot sell it out Foreign banks, such as Citi, Standard Charter,ABN in Taiwan ─ have already began to manage their portfolio. Mind-set •Headline risk is managed ─ Buy protection means give Credit risk is remote and RM can focus more on ‘cross sell’. ─ ‘Revenue’ away Estimate hedge benefit based on the ‘EL+CapCost’ – ‘Hedge ─ Cost’ ─Performance is reviewed One large corporate loan might wipe out our capital overnight. ─ largely based on ‘Revenue’ •Capital is not a ‘Free Lunch’ Low Incentive Capital allocation will be implemented in 2008. ─ Credit line can be relieved if ‘equity’ is sold out-most practices; ─ No capital pressure ─ however, some practices begin to recognize the remote of ‘tail ─ Credit line relief risk’. Copyright © 2007 ERIC KUO — Confidential 22
  23. 23. Restricted The possible way is to focus on the ‘Well-known’ names who usually have larger exposures and bring more ‘cross-selling’ revenue. Facts EAD RAROC (%) •15% of our 100 % = Capital/EAD per Client corporate clients account for 37% of exposure and consume 43 % of capital. 57 % Un-public 62.8 % 18 104 Million 85 % 6.7% •These small portion clients are ‘Public listed’ and are ‘well known’ by the investors. •Deliver higher 18 8.8 % 489 Million RAROC to CBG and 27.6% usually have thin 23.0% ‘credit spread’ and ‘larger exposure’ 3.9 % 429 Million 41 TSE 7.0% 2.8% 5.3% •Usually recognized 15 10.2 % 301 Million ROTC 2.0% as ‘Good’ asset and 7.9% 5.7% 3.0% Public Offering has less credit 29 4.0% 9.7% 129 Million 4.3% 3.2% OTC concern. # of Client EAD AIRB Capital 19 Avg = 141 Million Should be our first target. Copyright © 2007 ERIC KUO — Confidential 23
  24. 24. Restricted CPM and the new model of commercial banking Traditional model of commercial banking Credit Portfolio management change the game Obligor Investors Obligor CDS Deposit Loan Loan CLO Loan Bank pool Translate the ‘Risk’ A new model of Banker as the intermediary – –Globalization of financial commercial collecting savings and providing banking is markets emerging that is loans that were held to maturity –Increased economic volatility based on – Loan consumed ‘Capital’ competition and –Low price high competition open markets – Regulatory legislation Into ‘Opportunity’ watch BIS ratio and NPL –CDS market becomes more – Bank focuses on bi-lateral liquid. relationships –CLO market becomes more acceptable This model has been under –Capital can be free up through pressure for the past 40 years ‘Risk mitigation’ Copyright © 2007 ERIC KUO — Confidential 24
  25. 25. Restricted 更 Velocity , Cross-sell . 狀 Credit Portfolio • 理 • ─ CLO /CDS (BU ─ , ), Velocity . ─ CPM BU 利 理 • 度 ─ 度 ─ , Portfolio level limit ─ (Unexpected) boundary ─ ─ , 行 ─ CLO來Relieve Credit ─ Line • ─ CDS, ─ Sell protection, ─ CDS 來 Copyright © 2007 ERIC KUO — Confidential 25
  26. 26. Restricted Structured credit may result in different rating structure, below is a simple example to assess its benefits. Illustrative No Capital Relief A Rating NII Coupon Assume securitize 10,000 Credit asset 30% AAA 20 bps 6 Decision Scenario 60% BBB 100 bps 60 Original Asset Structure BB If Asset has good quality, hold ‘Equity’ with no capital 10% Equity 340 bps Cap 34 BIS=8% 800 relief benefit but has higher 100 OS 10,000 return 3% Capital relief B Hold ‘AAA’ and utilize ‘Cap NII 100(100bps) Rating NII Coupon 10,000 Relief’ to support other 30% AAA 20 bps 6 business Hold ‘AAA’ and partial 65% BBB 100 bps 65 ‘Equity’ BB 5 % Equity 580 bps 29 100 Source: Team analysis Copyright © 2007 ERIC KUO — Confidential 26
  27. 27. Restricted Tranched protection typically has a bigger impact on Economic Capital than it does on Expected Loss. ILLUSTRATIVE BBB BBB AA Hedged EL AAA Credit risk is remote EL 0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 Retained Ecap (Pre-deal) Ecap (post-deal) ~ Ecap (pre-deal) Tail risk . Pre Deal Post Deal Economic Capital (AA solvency) 6.2% 2.3% UL 3.2% 2.7% Average Default Correlation 5.1% 4.1% EL 3.6% 3.5% Source : IACPM , Oliver Wyman penal discussion Copyright © 2007 ERIC KUO — Confidential 27
  28. 28. Restricted In order to allocate these capital savings to individual loans we can match the loss ratio with the loss amount and feedback to notional credit line relief. ILLUSTRATIVE Loss ratio 100% 50% 0 1 2 3 4 5 6 7 8 9 10 11 12 Loss($) Retained Hedged / Sold to investor Equity tranche 0 1 2 3 4 5 6 7 8 9 10 11 12 Loss($) 1 2 3 4 5 Loss ($) (Pre-deal) 6 7 8 9 10 11 12 1 2 3 4 5 6 6 6 6 6 6 6 Loss ($) (Post-deal) 100 100 100 100 100 100 86 75 67 60 54 50 Loss Ratio% (Post/Pre) There are no In percentage terms, savings at the savings are greatest attachment point along with loss increases Copyright © 2007 ERIC KUO — Confidential 28

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