MANAGING BANK RISK
BARBARA FAVA, PFM ASSET MANAGEMENT
JUNE MATTE, PUBLIC FINANCIAL MANAGEMENT
JIM MATTEO, UNIVERSITY OF VIRGINIA
Market Capitalization (Billions)
Change in
Market Value
2
Query to Bank
Dear Sirs,
One of my checks was returned
from your bank marked
‘insufficient funds’. In view
of current developments in
the credit market, does that
refer to me or to you?
3
Credit Rating Trends
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Number of Banks
30
25
20
15
10
5
0
Dec 2006
Dec 2007
Dec 2008
Dec 2009
Dec 2010
Dec 2011
Oct 2012
• Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity.
4
Risks to the University
• Financial
– Loss of Principal
– Insufficient Liquidity
– Access to Credit Markets
• Operational
• Opportunity Cost
5
Cash & Investment Exposure
Cash
Investments
• Deposit Balances
• Liquidity
• Investment
Sweeps
• Principal Risk
• Diminished Market
Value
• Loss of Credit
Enhancement
• Liquidity
• Opportunity Cost
• Custody
6
Investment Custody
7
“Your Purchasing Card is fine. I’m just
checking that your bank hasn’t expired!”
8
Operational Risk
•
•
•
•
•
Purchasing Card
Merchant Card Processing
Campus Card
Payroll Card
On Campus Branch/ATM
9
Enterprise Management
• Diversity of instruments, parties and
potential credit quality
• New paradigm for thinking about banking
partners
– Fewer highly rated players
– Many new entrants in new roles
• Evolution in types of debt instruments
available driven by changes in market
10
11
Letter of Credit Provider Ratings
as of October 2012
35
Number of Banks
30
25
20
15
10
5
0
• Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity.
• Source: Bloomberg Finance
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Manage Risk Across the Spectrum
Letters of Credit/Credit
Enhancement/Liquidity
– Put Risk
– Trading Spreads
– 2a7 Issues
Swaps
– Counterparty Risk
Lines of Credit
Direct Placements
– Acceleration Risk
– Cross Default
13
Hierarchy of Credit
Bank
BankCredit
CreditQuality
Quality
BBB/Baa
A-/A3
Direct Placements
A
A+/A1
Lines of Credit
AA-/Aa3
AA/Aa
AA+/Aa1
AAA/Aaa
Swaps
Letters of Credit/Credit
Enhancement/Liquidity
14
Hierarchy of Credit
Bank Credit Quality
BBB/Baa
A-/A3
Direct Placements
A
A+/A1
Lines of Credit
AA-/Aa3
AA/Aa
AA+/Aa1
AAA/Aaa
Swaps
Letters of Credit/Credit
Enhancement/Liquidity
15
Hierarchy of Credit
Bank Credit Quality
BBB/Baa
A-/A3
Direct Placements
A
A+/A1
Lines of Credit
AA-/Aa3
AA/Aa
AA+/Aa1
AAA/Aaa
Swaps
Letters of Credit/Credit
Enhancement/Liquidity
16
Hierarchy of Credit
Bank Credit Quality
BBB/Baa
A-/A3
Direct Placements
A
A+/A1
Lines of Credit
AA-/Aa3
AA/Aa
AA+/Aa1
AAA/Aaa
Swaps
Letters of Credit/Credit
Enhancement/Liquidity
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Letters of Credit
• Facility expirations in 2011 had minimal
impact
• Good pricing
– Low VRDB issuance
– Lots of competition
• Overall supply and VRDBs supply is low
• Banks no longer requiring other treasury
service relationships
• Tenors are typically 3 years or less
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Direct Loans
• Borrowers opting for direct loans instead of
public sale
–
–
–
–
Lower transaction costs
Easier implementation
No credit ratings
No public disclosure
• Longer tenors for variable rate transactions
(4-10 years)
• Fixed rate typically sold with 20-30 loan and
mandatory tender in 4-10 years
19
Direct Loans Share VRDBs Risk
• Bank renewal/Refinancing Risk
• Obligation to Repay Loan Accelerates at
Term
– Many issuers do not have cash on hand or
budget flexibility to cover accelerated repayment
• Immediate acceleration due to rating or
default triggers
• Unknown costs related to changing
regulatory environment
Source: Moody’s Investors Service
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Direct Loans Reduce Some Risk
• Alternative to Variable Rate Demand Bonds
• Increases availability of liquidity at renewal
• Limited refinancing risk
– For VRDBs, failed remarketing can occur at any
time
– Credit deterioration of bank or general market
dislocation could result in failed remarketing of
VRDBs
Source: Moody’s Investors Service
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Existing Swaps
• Continued focus on counterparty risk
– Understand collateral thresholds
– Consider replacing counterparties
– Understanding Additional Termination Events
(ATEs)
• Treatment of swaps in debt restructuring
• Review documents to see whether swap is
tied to existing debt structure (i.e. tied to
current LOC provider)
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“LOOKS SOLID ENOUGH TO ME!”
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Holistic Approach
•
•
•
•
Cash, Investments, Debt, Operations
Understand enterprise risk
Diversify
Balance Credit Quality, Cost, Service and
Institutional Exposure
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Bank Risk Matrix - Debt
Treasury Relationship
Matrix
Long Term Debt Rating
Bank 1
Bank 2
Bank 3
Bank 4
Bank 5
Parent Rating
Bank Rating
Debt Exposure
Swap Counterparty
Bond Trustee
Line of Credit
Liquidity and Letters of
Credit
Remarketing Agent
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Bank Risk Matrix - Investment
Treasury Relationship
Matrix
Cash and Investments
Deposit Accounts
Savings Accounts
Repurchase Agreements
Money Market Funds
Bank 1
Bank 2
Bank 3
Bank 4
Bank 5
Commercial Paper and
Corporate Notes
Foundation
Endowment
Security Custody
Securities Lending
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Bank Risk Matrix - Operations
Treasury Relationship
Matrix
Operations
Bank 1
Bank 2
Bank 3
Bank 4
Bank 5
Banking Services
Payroll Card
Merchant Card
Travel & Entertainment
Card
Integrated Payables
On Grounds Branch/ATM
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A Case Study in Managing
Bank Risk
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Risk Management Efforts
Enterprise
RM
Department
RM
Event RM
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U.Va. Treasury Dept. RM
1.
2.
3.
4.
5.
Adopt a Risk Mgmt. Approach
Identify Risk Events
Score Risks
Develop Risk Response
Measure and Monitor Risk
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1. Adopt a RM Approach
COSO’s ERM – Integrated Framework
http://www.coso.org/documents/coso_erm_executivesummary.pdf
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2. Identify Risk Events
Risk
Categories
Strategic, Operating,
Compliance,
Reporting
Strategic
Strategic
Treasury Objective
Risk (threat or opportunity)
Optimize Cash Operations
Undefined Risk Tolerance
Optimize Returns on Financial Assets
Mismatch between asset and liability
portfolios
Operating Optimize Cash Operations
The impact of a Reduction in
Operating Budget Sources
Operating Optimize Cash Operations
Cash Forecast Inaccuracy
Operating Provide Effective Solutions for Customers
Risk of insufficient debt capacity
Facilitate Efficient and Cost Effective Access
Reporting to Capital
Insufficient Timing and Adequacy of
External Debt Reporting
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2. Identify Risk Events
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3. Score Risk Exposures
Risk
Categories
Strategic,
Operating,
Compliance,
Reporting
Treasury Objective
Strategic
Risk (threat or opportunity)
Likelihood Impact
Total
Score
(L*I)
Velocity
Counterparty underperformance risk
2
4
8
3
Optimize Returns on Financial Assets
Operating
Optimize Cash Operations
Counterparty Relationship Team Risk
2
3
6
3
Strategic
Facilitate Efficient and Cost Effective Access
to Capital
Inadequate liquidity counterparty
diversity
2
3
6
3
Operating
Optimize Cash Operations
Cash Operations Counterparty Failure
1
5
5
5
Operating
Optimize Cash Operations
Counterparty Credit Risk - Deposits
1
5
5
5
Compliance Optimize Returns on Financial Assets
Counterparty Fraud
1
5
5
5
Compliance Optimize Returns on Financial Assets
Poor counterparty internal controls
1
5
5
5
Counterparty key person risk
2
2
4
3
Strategic
Optimize Returns on Financial Assets
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4. Develop Risk Response
•
•
•
•
Retention
Insurance
Avoidance
Mitigation
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5. Measure and Monitor Risk
U.Va. Bank Risk Matrix – Debt (Pre-2008)
Treasury Relationship
Matrix
Bank of
America
Bank of
New
Goldman
York/Mellon
Sachs
JPMorgan
Chase
Morgan
Stanley
Lehman
Bros.
Merrill
Lynch
Wells Fargo
Long Term Debt Rating
Parent Rating
AA/Aa1
A+/Aa2
AA-/Aa3
AA-/Aa2
AA-/Aa3
A+/A1
A+/A1
AA+/Aa1
Bank Rating
AA+/Aaa
--/Aaa
--/Aa3
AA/Aaa
AA-/Aa3
A+/A1
--/--
AAA/Aaa
Debt Exposure
Swap Counterparty
$50 million
Bond Trustee
Line of Credit
$50 million
X
$250 million
Liquidity and Letters of Credit
Remarketing Agent
$300 million
CP
$82 million
VRDB’s
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5. Measure and Monitor Risk
U.Va. Bank Risk Matrix - Debt
Treasury Relationship
Matrix
Bank of
America/
Merrill
Lynch
Bank of
New
Goldman
York/Mellon
Sachs
JPMorgan
Chase
Morgan
Stanley
Lehman
Bros.
U.S. Bank Wells Fargo
Long Term Debt Rating
Parent Rating
Bank Rating
A-/Baa2
A+/Aa3
A-/A3
A/A2
A-/Baa1
A+/Aa3
A+/A2
A/A3
AA-/Aa1
A /A2
A+/Aa3
A/A3
AA-/Aa2
AA-/Aa3
Debt Exposure
Swap Counterparty
$50 million
Bond Trustee
$50 million
X
Line of Credit
$100 million
$50 million $100 million
Liquidity and Letters of Credit
Remarketing Agent
$300 million
CP (1/2)
$300 million $78 million
CP (1/2)
2003A
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5. Measure and Monitor Risk
U.Va. Bank Risk Matrix – Cash and Investments
(Pre-2008)
Treasury Relationship
Matrix
Cash and Investments
Deposit Accounts
Savings Accounts
Repurchase Agreements
Money Market Funds
Commercial Paper and
Corporate Notes
Foundation
Endowment
Security Custody
Bank of
America/
Merrill
Lynch
Bank of
New York/
Mellon
Goldman
Sachs
JPMorgan
Chase
Morgan
Stanley
SunTrust
Bank
U.S. Bank Wells Fargo
X
$300 million
Portfolio
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5. Measure and Monitor Risk
U.Va. Bank Risk Matrix – Cash and Investments
Treasury Relationship
Matrix
Cash and Investments
Deposit Accounts
Savings Accounts
Repurchase Agreements
Money Market Funds *
Commercial Paper and
Corporate Notes
Foundation
Endowment
Bank of
America/
Merrill
Lynch
Bank of
New York/
Mellon
Goldman
Sachs
JPMorgan
Chase
Morgan
Stanley
SunTrust
Bank
U.S. Bank Wells Fargo
X
$390,000
Security Custody
$640,000
$200 million
Portfolio
$540,000
$100 million
Portfolio &
PFM Funds
* Pro-Rata Share of Mutual Fund Holdings
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5. Measure and Monitor Risk U.Va.
Bank Risk Matrix – Operations (Pre-2008)
Treasury Relationship
Matrix
Operations
Bank of
America/ Bank of
Merrill
New York/ Goldman JPMorgan
Lynch
Mellon
Sachs
Chase
Banking Services
X
Payroll Card
X
Merchant Card
Travel & Entertainment
Card
X
Integrated Payables
X
On Grounds Branch/ATM
X
Morgan
Stanley
SunTrust
Bank
U.S. Bank
Wells Fargo
X
X
X
X
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U.Va – What Next?
•
•
•
•
•
Diversify Operating Risks
Explore better ways to measure risk
Use risk register to prioritize work
Find natural areas of avoidance
Implement monitoring approach
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QUESTIONS?
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Contact Information
Barbara Fava, PFM Asset Management
favab@pfm.com
June Matte, Public Financial Management
mattej@pfm.com
Jim Matteo, University of Virginia
jsm6y@virginia.edu
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PFM Disclosures
The material presented by PFM Asset Management and Public Financial
Management (PFM) is based on information obtained from sources generally
believed to be reliable and available to the public, however PFM cannot guarantee
its accuracy, completeness or suitability. This material is for general information
purposes only and is not intended to provide specific advice or a specific
recommendation. All statements as to what will or may happen under certain
circumstances are based on assumptions, some but not all of which are noted in
the presentation. Assumptions may or may not be proven correct as actual events
occur, and results may depend on events outside of your or our control. Changes in
assumptions may have a material effect on results. Past performance does not
necessarily reflect and is not a guaranty of future results. The information
contained in this presentation is not an offer to purchase or sell any securities.
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