Dexia presentation lessons for australian banks

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Dexia presentation lessons for australian banks

  1. 1. Section I: History DexiaSection II: Dexia’simbalancesSection III: Take-awaymessages Australian banks 1
  2. 2. PASSIONATE ABOUT RISK MANAGEMENT• Twenty-year track record in risk management (financial institutions, structured finance, corporate banking, commercial real estate, public finance, trade and project finance, as well as sovereign risk).• Former role at Dexia, as Head Financial Markets Credit Counterparts, I was responsible for: ① Risk management of counterparty & issue risk in relation to ABS/CDO, sovereign risks and financial institutions (total combined portfolio of $150bn consisting of more than 3,000 counterparties), including Basel 2 IRBA model management on Banks, Insurance Cies, covered bonds, Countries and ABS/ CDO (cash flow models) ② Bond pricing in relation to a total bond portfolio of $220bn, model management of „mark-to-model‟, as well as calculation of AFS reserves. ③ Calculation of CVA and development CVA tool. ④ Impairment process (collective & specific impairments in relation to financial markets activities). ⑤ Risk reporting on all bond positions within the group as well as exposure management on financial institutions. ⑥ Monitoring Off B/S derivatives exposures (BtB CDS portfolio of $20bn)• In my last position I managed a team of more than 55x risk analysts based in Brussels, Paris, and New York.• For more than 15 years I have had an overseas career with positions held in the USA, UK, Germany, Italy, Spain, France, Luxembourg, and Belgium.• I hold an Executive MBA from the University of Washington, Post Graduate in International Relations – UCL, and Master in Applied Economics - University of Antwerp. 2
  3. 3. Australian banks are still unsure what European troubles mean for them.Is what happening with Dexia in Europe a regional phenomenon only affecting the Europeans themselves?Are there implications for Australian banks despite its distance from the epicentre of the crisis? In a globalised world there are no local crisis anymore and therefore Australia should expect the European crisis to have an impact on its economic situation and performance over the coming years, if not decades. Although Australian banks cannot influence events in Europe, it can prepare for the effects: limited exposure to potential sovereign defaults; increasing difficulties in accessing international capital when European investors are withdrawing from global markets to shore up their domestic operations; and a slowdown of Chinese exports to Europe, which will have an impact on Chinese demand for Australian commodities. Beyond these direct effects of the European crisis, Australian banks could learn from the long-term consequences of ever expanding activities propelled by debt-finance. 3
  4. 4. Disclaimer: The comments in this presentation do not represent the thoughts, intentions, plans or strategies of Dexia. They are solely the author‟s personal opinion. Allinformation, text, images and layout are the author‟s exclusive property. This presentation may contain, or be linked to, advice or statements from third parties. The authormakes no representation as to the accuracy, completeness, timeliness or suitability of such information and the author has not, and will not, review or update suchinformation and caution you that any use made of such information is at your own risk. Some of the information contained in this presentation may also have been preparedor provided by third parties and may not have been verified by us. The author hereby excludes any liability arising out of any preparation or provision of such information forthis blog and make no warranty as to the accuracy, suitability or completeness of any such information. 4
  5. 5. Strong “Retail & Market leader Key player “Project Commercial Banking” “Public Finance” & corporate ($70 bn assets): ($240 bn): Belgium, Finance” ($45 bn): Belgium, Luxembourg, France, Italy, Iberia, EU-wide, USA, Turkey, and Slovakia and USA Mexico, and AUS. Mid-size player Top 10 “Global “Assets under Custodian” Management” ($2.7 trillion – RBC ($100 bn – DAM) Dexia)Dexia Group => 35,000 people spread over 40 countries alongside four main entities, being:• Dexia Bank Belgium• Dexia Credit Local• Dexia Banque International a Luxembourg• Denizbank“Treasury & Financial Markets” (TFM) until 2009 used to be a separate business line, and with a Legacy bond portfolio ofclose to $200 billion. 5
  6. 6. Key figures (source: Annual Report & Rating reports; IFRS except for 2001 under Dexia GAAP) 10 years activity „wasted‟ Gross Revenues $80bn (2001) => $135bn (2008) Total Assets $440bn (2001) => $905bn (2008) BUT Customer Deposits $105bn (2001) => $128bn (2008)Ratings (Fitch/ Moody’s/ S&P)Dec 2007: AA/ Aa1/AA+ Comments:Dec 2011: A+/ Baa1/ BBB+ • Loss in 2008 due mainly to FSA ($2.0 bn loss on sale to Assured and $2.5bn impairment charge on remaining FSA RMBS) • Loss in 2011 due mainly to loss on sale of Dexia Bank Belgium ($5.1bn), impairment of Greece ($4.2bn), loss on sale FP portfolio ($2.4bn), and loss on sale Dexia Municipal Agency ($1.25bn). 6
  7. 7. • Prior to 2008, group‟s high ratings (AA/ Aa1/ AA+) granting easy access to wholesale funding. $325bn short term funding outstanding by end October 2008 representing 43% of total B/S• 2001 to 2007: fast geographical expansion of the public & wholesale banking activities beyond the group‟s domestic base: • Lending to core countries (BE, F, Lux) increasing 34% vs. 207% for rest of the world. • Lack of LT stable funding to support the expansion; profitability mainly extracted from liquidity transformation. • Large off B/S positions in the US through the development of the SBPA business.• 2006 and 2008: acceleration in build-up of bond portfolios amounting to $253 bn as end December 2008 and leading to an excessive gearing ratio (portfolio size 25x group‟s equity). • Diversification of FSA outside its primary credit enhancement activity leading to exposure to the US subprime market and US Dollar liquidity mismatch.• 2009-mid 2011, execution of the strategic restructuring on schedule• 3Q11: degraded environment forcing a new response 7
  8. 8. Disclaimer: The comments in this presentation do not represent the thoughts, intentions, plans or strategies of Dexia. They are solely the author‟s personal opinion. Allinformation, text, images and layout are the author‟s exclusive property. This presentation may contain, or be linked to, advice or statements from third parties. The authormakes no representation as to the accuracy, completeness, timeliness or suitability of such information and the author has not, and will not, review or update suchinformation and caution you that any use made of such information is at your own risk. Some of the information contained in this presentation may also have been preparedor provided by third parties and may not have been verified by us. The author hereby excludes any liability arising out of any preparation or provision of such information forthis blog and make no warranty as to the accuracy, suitability or completeness of any such information. 8
  9. 9. Findings prior to 2008:1. Developments far from core markets2. Heavy reliance on wholesale debt markets3. Excessive leverage4. High exposure to the U.S. market5. Significant derivatives portfolio causing a liquidity drain in terms of collateral postingStrategic plan – Actions since 2008:1. Refocus on core commercial franchise and tapping into LT funding markets2. Reduce liquidity mismatch and reduce ST funding3. Deleveraging – derisking4. Disposal of FSA Insurance5. Reduction of the OTC exposures through CCP and TriOptima6. And re-organisation in terms of risk governance 9
  10. 10. Dexia findings:• Presence in markets with no relevant commercial franchise, local funding, or potential for profitable growth.Dexia actions:• Discontinuation of activities in Australia, CEE (excl. Slovakia), Mexico, India, Japan, and Scandinavia.• Confirmation of commercial franchise in Belgium, France, Luxembourg, Turkey, Italy and Iberia.• Enhance tapping into local long-term funding sources in Germany and Switzerland.Quick-fix for Australian banks:• Concept of „self-funding‟ bank. • Only grow a business where a relevant commercial franchise makes sense, potential for profitable growth exists, and a source for tapping into local funding. 10
  11. 11. Dexia findings:• Reliance wholesale funding markets to fund loan & securities portfolio (only 16% funded by customer deposits - 2008) ST whole sale funding $325 bn (2008) $108bn (2011) Customer deposits $130 bn (2008) $25 bn (2011) Lending & Securities (*) $793 bn (2008) $370 bn (2011)Dexia actions:• Substantial rebalancing liquidity structure: 20% of B/S funded whole sale short-term end 2011 (from 40% end 2008).(*) includes Advances to BanksQuick-fix for Australian banks:• Not only the loans-to-deposits ratio should be monitored but also the funding of the securities portfolios. Cust. Dep./ (Lending + Securities): 60% (up from 50% end 2009)• As of end 2011, wholesale funding still represents approximately 40% of total funding (excluding derivatives), and half of it is sourced from offshore markets (although importantly the lion share is long-term funding).• Short-term debt Financing liabilities fell from 30% in 2008 to 20% in 2011. 11
  12. 12. Dexia findings:• End 2008, close to $253bn bond portfolio built as part of the public finance activity or liquidity management.• B/S was close to 40x „common‟ equity ($905bn vs. $21bn)Dexia actions:• Mid-2011 bond portfolio reduced to $118bn with an average nominal loss close to 1%.• Additionally the $14bn of bonds in relation to FSA Financial Products portfolio was sold end July 2011.Quick-fix for Australian banks:Australian banks have an average „leverage‟ ratio of around 17x (cf. Total assets/ common equity) way below the 33xmultiple set forth by Basel 3.Australian banks have improved their Tier 1 capital ratios (from around 7% in 2008 to 10% in 2011). 12
  13. 13. Dexia findings:• Exposure to the U.S. financial guarantee business through FSA• $425bn insured portfolio, of which $110bn insured ABSDexia actions:• Disposal of FSA Insurance in 4Q08 to Assured Guaranty, and keep the FSA Financial Products ABS portfolio ($16bn) with first loss of $4.5bn covered by Dexia and the remainder under state guarantee. • 4Q08 sale resulted in a loss of $2.0bn and impairment charge of $2.1bn, and this contributed to the confidence crisis that shook the bank in 4Q08.Quick-fix for Australian banks:• Australian banks generally do not have „large‟ offshore activities with the exception of: • ANZ Banking Group – SE Asia representing close to 10% of total assets. • NAB Banking Group – UK retail market• Necessity for building solid local risk management with senior & middle management expatriates from parent Cie as well as strict follow-up in terms of reporting, guidelines and risk control by Risk Management Group (RMG).• But at the same time RMG must „understand‟ new market culture environment of the overseas affiliates. 13
  14. 14. • To make the most of Group competences, Risk Management organisation is based on specialist competence centres on which local risk management can rely.• Dexia used Basel II IRBA methods• In terms of risk governance, Risk Management was chairing all credit committees and had a veto right in terms of decisions.• Competence Centres relating to respectively Market, ALM, and Operational Risk are organised at the Group level providing support to the RM of the local entities• Dedicated Competence Centres on Credit Risk Management are organised along PWB and RCB business lines as well as one for the Risk Management for Financial Markets. • Risk Management Financial Markets had about 90 people of which around 60 people working in Financial Markets Credit Counterparts (FMCC). • FMCC was in responsible for the risk management of ABS/CDO, Financial Institutions, the bond pricing, calculation of CVA and AFS reserves. Later on, early 2011, Sovereign counterparties were also part of the scope of FMCC. 14
  15. 15. Disclaimer: The comments in this presentation do not represent the thoughts, intentions, plans or strategies of Dexia. They are solely the author‟s personal opinion. Allinformation, text, images and layout are the author‟s exclusive property. This presentation may contain, or be linked to, advice or statements from third parties. The authormakes no representation as to the accuracy, completeness, timeliness or suitability of such information and the author has not, and will not, review or update suchinformation and caution you that any use made of such information is at your own risk. Some of the information contained in this presentation may also have been preparedor provided by third parties and may not have been verified by us. The author hereby excludes any liability arising out of any preparation or provision of such information forthis blog and make no warranty as to the accuracy, suitability or completeness of any such information. 15
  16. 16. • Australian banks came through the GFC relatively unscathed thanks to more solid regulatory system as well as a more conservative risk appetite.• Australia‟s banking industry has emerged from the GFC in a comparatively strong position, and its reputation globally has been enhanced.• But challenges in terms of cost and stability of funding, increasing competitive pressures and implementation of international regulatory reforms.Australian market specific-issues Australian bank-specific issues• Mining & farming industry (19% of GDP and 60% of • Funding mix & reliance on overseas borrowing exports)• High household debt (126% vs. GDP) despite gradual • Refi risk Gvt guaranteed debt in period 2012- „private‟ deleveraging 2014• Concentration risk on China & India (33% of exports) • Increased competition& cost of funding• Narrow mining export product base (coal & iron ore) • Reduced profitability• Housing market • Contagion risk due to oligopoly• Business model• Loan Mortgage Insurers thin capital • Stronger regulation than Basel• Competition from super funds diverting savings from bank • Large mortgage loan portfolio deposits• High AUD 16
  17. 17. Economic Capital management & profitability:• Because of Basel 3 more focus on highly liquid assets thus hurting profitability of the banks.• Because of Basel 3 higher capital requirements which combined with revenue pressures will be concern for delivering good RoE (H1 2012 results average RoE at around 16%).• Because of deleveraging with households and businesses, credit growth will slow down and hence revenue growth as well.• Thus domestic efforts should be on productivity and reshaping staffing mix while also providing good systems and software.• Economic Capital Management should be STAKEHOLDERS IN DAY-TO-DAY CREDIT DECISIONS and also a key parameters for credit surveillance by Risk Management.• Senior risk managers must familiarize their teams to those new challenges. 17
  18. 18. Risk management organisation:• Risk management CHAIRING ALL CREDIT COMMITTEES + VETO POWER. But Risk Management also no „Ivory Tower‟ mentality.• „New‟ risk exposures on the books: MARKET & CREDIT RISK PLUS ALM MUTUALISE RESOURCES & TOOLS AND SHARE INFORMATION, and be involved in decision process (cf. the impact RWA, liquidity ratios, cost of hedging (swaps), etc).• Surveillance & risk monitoring of „existing‟ risk exposures (securities portfolio) : PRO-ACTIVE MANAGEMENT OF HTM positions - credit risk + market risk working together.• Dedicated Legal „Financial Markets‟ team should exists to work closely with the credit analysts monitoring the securities portfolio.• Risk management = only physical place for Credit Files Record Keeping (= solid logistics is backbone of any robust risk management). 18
  19. 19. Credit risk & reporting:• In relation to risk reporting = INTEGRATED RISK REPORTING: • Establish COMMON DATABASE of ALL securities positions in the group instead of database with interlinking between many different systems. • Adequate integrated reporting on available central bank eligible securities within the Group. • Build EARLY WARNING SYSTEM on securities portfolio with a DASHBOARD OF RISK INDICATORS in relation to market risk (changes in pricing or spread, cost to unwind swap), credit risk (amount, rating, etc), and liquidity risk (repo/ central bank eligibility, cost of carry, etc).• In relation to monitoring asset quality: • House prices remain high by many metrics, increasing SYSTEM SENSITIVITY TO INCREASES IN INTEREST RATES & UNEMPLOYMENT, AND/ OR BANK LENDING CONTRACTION. Conduct worst- case scenarios. • Even though asset quality in B/S exposures is key to monitor, PAY ATTENTION to also OFF B/S POSITIONS such as derivatives (BtB CDS, NBT, TRS, etc). • The latter can pose a documentation risk and foremost a liquidity drain in terms of collateral posting. When hedging positions pay close attention to the liquidity drain that collateral posting can cause. Look at Downgrade Clause, Minimum Transfer Amount, etc. • Make sure that all ISDA and CSA have been signed and put in place (involve Legal „Financial Markets‟).• Once a year conduct a RISK MAPPING EXERCISE where Risk Management needs to map ALL the risks - not just asset quality~ and/ or market-driven but also in relation to gap analysis on systems, processes, policies, risk measurement, compliance, quality control ratings, etc. And based on this annual risk mapping exercise draft an action plan. 19
  20. 20. Funding mix:• Concept of SELF-FUNDING BANK. Ideally grow a (OVERSEAS) business where a relevant commercial franchise makes sense, potential for profitable growth exists, and a source for tapping into local funding. Growing is not just focussing on the assets‟ side but also on funding.• Not only the loans-to-deposits ratio should be monitored but also the funding of the securities portfolios (cf. 16% of B/S).• Keep permanent efforts to reduce reliance on wholesale funding (end 2011 still represented approximately 40% of total funding (excluding derivatives), and half of it was sourced from offshore markets (although importantly the lion share is long-term funding)).• Asset portfolio structure with heavy reliance on residential properties, and wholesale funding driven by imbalance between household borrowings and deposits. And future funding patterns are dependent on housing market developments and household savings patters.• According to the RBA, Australian financial institutions had offshore borrowings of just $40 billion in January 1990, $123.5 billion in January 2000, and $314 billion in January 2012. • In the context of the GFC this reliance on international capital is considered a weakness reason. • Fortunately in 2012 deposit growth outpace credit growth making wholesale funding needs more manageable.• Dominance of four majors with similar funding patterns expose them to contagion risk due to: • Subdued recovery in RMBS market adversely affecting smaller market participants to raise funding at competitive rates. • Foreign banks withdrawing or scaling back their Australian operations. • Further consolidation in the Australian banking sector since GFC.• Home loan market share increased from around 60% before the onset of the GFC in mid-2007 to around 73%.• FUNDING ALTERNATIVES: ① Fostering retail bond market w/ support distribution channels combined w/ finding ways to flow money from super funds to banks . ② Re-emergence of RMBS securitisation with support of AOFM as key investor. ③ Covered bonds issuance ($130bn cap for the Four Majors, and only $30bn has been used up now – depends on window of opportunity in market). 20
  21. 21. Liquidity:• Implementation of LIQUIDITY COMPETENCE CENTERS in regard to central bank eligible securities. • For example FO/ BO/ MO in NY responsible for a daily follow-up of all FED eligible securities available in the group regardless of where the securities are located. On a Group level the Treasury Management Centre is supported by the Competence Centres, sub-divided according to their main currency, which are responsible for the liquidity gaps and end-of-day squaring for their competence currency.• New definition & classification of what bank considers „AVAILABLE SECURITIES‟: Only securities that can be used in prime bilateral repo (ie. through Clearnet and LCH) or central bank operations can be used to calculate liquidity buffer.• INTEGRATED REPORTING TOOLS to follow up consolidated liquidity positions intra-day and to run liquidity projections. CLM architecture project must have the highest priority (Basel 3). Up to 6 conference calls per day were organised with all entities of the group. • The liquidity of a security became as important as its rating.• SIMULATION/ MODELLING COLLATERAL NEEDS for Guaranteed Investment Contracts, CSA contracts as well as of securities „at risk‟ (securities scoring low in eligibility criteria).• WORKING WITH CLEARING SYSTEMS: Important parameter of a business continuity procedure is not only to have a solid limit structure but also to have full understanding of the different clearing systems, such as CLS, and their respective limit architecture. 21
  22. 22. When looking at Europe, Australia as a country may well see its own future. The European public debt crisis as well asthe Dexia debacle is a wake-up call as Australian banks could learn from the long-term consequences of everexpanding activities propelled by debt-finance.Already the business models of Australian banks are being re-drafted in response to:- changes in terms of regulation,- deleveraging by households and businesses,- wholesale funding market volatility, and- technology developments.Clearly, balance sheets become a liability lead strategy with a permanent quest for more stable funding. Fortunately inAustralia deposit growth has been stronger than credit growth making for the time being funding needs moremanageable.And amongst all banks in the Western world, Australian banks have most likely the brightest outlook. And one way toinsure it remains the case for the future, Australian banks should welcome in their midst „overseas‟ risk managers thatcould bring a fresh view on risk processes & tools and help better prepare for the future.If Dexia is not to become the blueprint for Australian banks‟ future, Australian banks must ensure that Dexia‟s woes arenot repeated in Australia. 22

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