Restricted




    Credit Portfolio
    Management Introduction




    2008/08/04




1
Restricted




Agenda




1. Brief Introduction of Credit Portfolio Management




2. Reshape portfolio Through Portfolio ...
Restricted




   A CPM in bank is usually either led by risk or within BU.



                Chief Credit Officer       ...
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         CDS market in Japan grows at an exponential rate, even though the
         lending rate is at record ...
Restricted

   The credit derivatives market in Taiwan is growing but is far smaller compare
   to Japan’s. Most of the he...
Restricted

    The implementation of the ‘limit boundary’ as a means to force LoB to
    reduce risk. Also to prevent fro...
Restricted

      Major hedge decision point for the LoB lies on if they can arbitrage even
      they are forced to do so...
Restricted
 Externally, the structure of the hedge activities depend on clients’ needs. I
 don’t generally responsible for...
Restricted



      No capital-relief in our recent CLO experience.
                                                      ...
Restricted

   Although there are many types of role in the CPM , we are in the
   advisory stage.




We are here




   ...
Restricted




Agenda




1. Brief Introduction of my experience in Credit Portfolio
Management



2. Through Portfolio An...
Restricted




     Utilizing the ECap to identify the concentration risk .
                                              ...
Restricted

     Leverage the RAROC metric to gauge if the risk / return of current
     portfolio is justified.
         ...
Restricted




Agenda




1. Brief Introduction of my experience in Credit Portfolio
Management



2. Through Portfolio An...
Restricted

Defining the objectives of credit portfolio management will help to determine
the trade ideas. No matter which...
Restricted




    Understanding the ‘risk’ is the key factor of Investing in credit instruments.



 Analyzing the availa...
Restricted

   Modern portfolio theory suggests us that we can enhance the portfolio
   performance by re-weighting the cu...
Restricted




        Issues in developing CPM function
1 Loan origination:                 2 Diagnosis:                 ...
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  1. 1. Restricted Credit Portfolio Management Introduction 2008/08/04 1
  2. 2. Restricted Agenda 1. Brief Introduction of Credit Portfolio Management 2. Reshape portfolio Through Portfolio Analysis 3. Ideas of portfolio improvement 20080804 Eric — Confidential 2
  3. 3. Restricted A CPM in bank is usually either led by risk or within BU. Chief Credit Officer CEO of Corporate Banking Group Credit Institutional Corporate Capital Market Retail Credit Integration Bank Credit Department Line of Credit Portfolio Credit Trading Securitization Business Responsibilities • Execution is done by ‘Capital market’. • Either through CDS or CLO • Analytical • Management Relationship Sales force Sales force Manager • Risk Solution • Other Basel 2 Focus more on analytical related issues Interact with and management LoB and aspects and to build Capital Market mechanism within the organization 20080804 Eric — Confidential 3
  4. 4. Restricted CDS market in Japan grows at an exponential rate, even though the lending rate is at record low. 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 6.49 43,118 Above 5 Year Taiwan Lending rate 76,669 Multi-Name CDS Japan Lending rate 6 200 183 143 4 3.22 1~5 Year 218,968 194,713 Single name 100 2 1.48 1.46 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 Central bank of Republic of China. 20080804 Eric — Confidential 4
  5. 5. Restricted The credit derivatives market in Taiwan is growing but is far smaller compare to Japan’s. Most of the hedge activities are private placement instead of done via trading desk. Over-banking result in a low margin Credit derivatives Volume comparison loan market Most of the hedging structure are rudimentary type.. Current average credit spread is around 120 bps in the loan market. ..mainly due to ,the Clients want to have simple structure. Large corporations usually utilize the syndication to finance their needs, the average spread is less than 120 bps…. 271,383 * Unit : US Million ..this adds the difficulties to reduce risk through capital market. 3,286 ** 1.2%*** 709 Hedge purpose 0.5 % ~1.2% Most likely **** can be placed through CDS & CLO Trading purpose 2,577 Market average Large loan spread corporates loan spread Japan Taiwan * Bank of Japan. Figures show the notional amount of transaction on the Aug 2007. ** End of April ,2008 ,Financial statistics abstract *** Average lending spread after the CP rate(90 days) Central bank of China 20080804 Eric — Confidential **** estimated by using syndication loan 5
  6. 6. Restricted The implementation of the ‘limit boundary’ as a means to force LoB to reduce risk. Also to prevent from the excuses of high hedge cost. Solution of expansion & constraint Industry Portfolio Limit Taiwan Overseas boundary Solution Challenge Market Size Opportunity •Subprime adds more •Credit link note Y Y Hi-Tech difficulty •CLO Room for Y N •Usually for the Service expansion •Buy insurance transaction based Financial lending Y Y •Loan sell •Most common Y Telecom •Sub -participation Manu- Reduce exposure facturing Y Limit Capped Current Exposure Risk needs to be transferred instead of simply being controlled. However, the reality is difficult to execute portfolio hedge. 20080804 Eric — Confidential 6
  7. 7. Restricted Major hedge decision point for the LoB lies on if they can arbitrage even they are forced to do so. ..financial group concerns about the P & L as well. Like most organizations in Taiwan Usually the regulatory capital relief plays an important role hedge activities tend to be viewed as a in making hedge decision .. waist of money. saving X Cost of Capital = Y Y Risk adjusted Risk adjusted profit before profit after EL Total Cost of Final Capital Capital Capital hedge hedge saving saving hedge Saving cost Usage Usage saving Or before after additional hedge hedge cost 20080804 Eric — Confidential 7
  8. 8. Restricted Externally, the structure of the hedge activities depend on clients’ needs. I don’t generally responsible for the structuring, only provide comments and support. Observations Clients will compare with other investment products Structured Generally prefer a product that is simple and transparent credit In terms of credit linked product, clients only interested in product the big names or the names they are familiar with. Clients general concern about the accounting treatment and impact to their financial report. Accounting treatment Especially when product requires ‘ Mark to market’ Some clients discuss the possibility of using this As collaterals investment as collaterals . 20080804 Eric — Confidential 8
  9. 9. Restricted No capital-relief in our recent CLO experience. Illustrative Rating NII Coupon Original Asset Structure 10,000 30% AAA 20 bps 6 •Structure of the CLO requires Cap BIS=8% 800 to meet the investors’ needs 60% BBB 100 bps 60 OS 10,000 •Relationship managers BB usually ask for the limit relief NII 100(100bps) 10% Equity 340 bps 34 100 20080804 Eric — Confidential 9
  10. 10. Restricted Although there are many types of role in the CPM , we are in the advisory stage. We are here 20080804 Eric — Confidential 10
  11. 11. Restricted Agenda 1. Brief Introduction of my experience in Credit Portfolio Management 2. Through Portfolio Analysis to reshape the portfolio 3. Ideas of improving portfolio 20080804 Eric — Confidential 11
  12. 12. Restricted Utilizing the ECap to identify the concentration risk . Illustrative Industry Concentration The chart exhibits the industry concentration risk. EC = RC If the EC is equal to the EC > RC illustrates the For the industries that EC demonstrates the risk AIRB Cap which means the higher risk or > RC, Banks need to dig is properly expressed risk is properly identified by concentration risk in UL into further to understand under Basel 2 using the Basel 2 capital context. formula. the formula, as shown in the ‘B’ -Profitability industry. A -Industry outlook Higher EC than RC, for EC > RC Zone B example the ‘A’ industry, -Relationship illustrates the the AIRB -Business strategy Require capital is under-estimate the Economic to capital and also is an good Capital before taking action. Opportunity Reduce illustration of ‘Concentration to Increase risk For those industries that Risk’. risk exposure EC<RC: exposure The causes of the concentration effect may Banks can consider result from : expansion after consider •Larger ‘exposure’ EC < RC stands for -Industry outlook •Rating the UL is lower than -Market size Basel 2‘s . •Recovery rate of collaterals -Cross-sell opportunity •Net interest income AIRB Capital •Correlation …of certain industries 20080804 Eric — Confidential 12
  13. 13. Restricted Leverage the RAROC metric to gauge if the risk / return of current portfolio is justified. Illustrative Return & Capital allocation Potential hedge names selection Most of the lending business rarely can deliver Lending business will inevitable faces industry risk adjusted profit, banks require to cross sell concentration, though, bank need to balance the more fee-based income to compensate the risk risk and return. taking activities. RAROC A Total X-Sell RAROC Cost of Capital A Cost of capital 24% of 100% of Capital total capital Miss pricing zone RAROC-Credit Asset Cost of capital RAROC-Incorporate Cross-Sell Credit RAROC Note: Industry classification is based on Moodys’ classification. Reason of industry concentration risk: GDP of a country is usually relies on certain industry. 20080804 Eric — Confidential 13
  14. 14. Restricted Agenda 1. Brief Introduction of my experience in Credit Portfolio Management 2. Through Portfolio Analysis to reshape the portfolio 3. Ideas of improving portfolio 20080804 Eric — Confidential 14
  15. 15. Restricted Defining the objectives of credit portfolio management will help to determine the trade ideas. No matter which type, recommend to be a ‘semi-profit’ center. •Challenge may face •Main focus Capital management : increase capital Less liquid credit market Purpose velocity – Are names available for hedge Capital relief is the theme Regulatory – Are the prices attractive capital Meet regulator’s requirement – Rarely full capital-relief can be management achieved, unless tenor, underlying, currency are fully matched – Taiwan’s regulator is more conservative on the structure of structured credit products Add Diversification through invest in credit Risk verification for the Investment – Invest in different Countries adds more opportunity Risk Return diversification effect – Who evaluate the risk – Usually portfolio unit will set up industry improvement Performance evaluation for the PSG specialist and manage portfolio across countries. – What is the criteria . Risk identification – Performance Metric used (EC or – Utilize Economic Capital RC) – KMV’s PM provides trade optimization function to give users ideas on which name to long and which name to short Effect estimation – Utilize portfolio model to understand the benefit of hedging and the effect of adding new names 20080804 Eric — Confidential 15
  16. 16. Restricted Understanding the ‘risk’ is the key factor of Investing in credit instruments. Analyzing the available names in the CDS market Price of CDS Short protection Running the Combining portfolio model to names from see the impact to current portfolio the existing credit and package it to portfolio before PD sell to clients making decision Buy protection Risk Grades Either based on EDF or in- house PD model 20080804 Eric — Confidential 16
  17. 17. Restricted Modern portfolio theory suggests us that we can enhance the portfolio performance by re-weighting the current portfolio. Conceptual Portfolio Performance Enhancement 12% Hedge : Reduce risk / uncertainty 1 -Tool : Buy CDS, Loan Sell, Insurance, Securitization Efficient Frontier 10% Enhance Yield : Invest in Higher Yield Return 2 given the same ‘risk’ 4 8% -Tool : Secondary loan, Sell 2 CDS, CDS Index, securitization. 3 Current Portfolio 1 6% Swap Asset 3 Synthetics : Reduce risk and utilize the 4 4% free up capital to invest in credit. 5% 15% 25% 35% Risk 20080804 Eric — Confidential 17
  18. 18. Restricted Issues in developing CPM function 1 Loan origination: 2 Diagnosis: • Decision process need to be streamlined • Does CPM has veto • Information of Regulatory capital /Economic Capital/ power over the loan RAROC/EP • Transfer pricing : EL+CapCost or origination. Market hedge price • Assets under managed • Be aware of interest • a Profit center or Cost center Public listed / Well known name /SME/ Bond/ conflict faces across CDS/CDO /country/Consumer • Scenario analysis on Portfolio organization model to see the effect of risk • Who owns the asset mitigations. 2 3 4 1 Diagnos 4 is Origination Distribution: Distrib Credit Management • Current distribution Executio ution Portfolio channel. n Credit Approval Manage- Primary Secon- • CDS Market in Asia is / Rating •Loan ment illiquid. dary Trading Market •Risk • CLO faces the sub- Market •CDS prime crunch. :RC/EC Loan pool •CLO •Return By countyr 3 :RAROC Rating Execution: /EP • Relationship with trading desk and securitization desk for both of the hedge and invest in credit activities. • Who pay for the cost . 20080804 Eric — Confidential 18

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