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US Money Center Banks

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US Money Center Banks

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

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