Share of Wallet & Pricing
Trends under Basel III
AFP Calgary Luncheon
Jason Palmer
November 19, 2014
Introduction: Citi’s Canadian
Citi has roots in Canada dating back to 1919 and has a substantial presence, with ~3,000 employees across
approximately 220 locations
Business lines in Canada
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Corporate & Investment Banking
Citi Markets and Securities Services
Treasury and Trade Solutions
Citi Technology Development Centre
Citi Private Bank
Citi Retail Services
CitiFinancial
Office locations
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2
Toronto
Mississauga
London
Montreal
Calgary
Vancouver
and 214 CitiFinancial branches
Sites per province
Corporate & Investment
Banking Presence
Discussion
 What is Basel III?
 How will it change banks behaviors?
What should corporates do to mitigate the
impact?
 Special Topic: Alternative Funding
Basel III:
What is Basel III?
The Move to Basel III
Basel III introduces radical changes in capital rules, new liquidity and leverage ratios as well as additional
rules for global systemically important banks.
Basel I: 1988
5
Basel II: 2005
Basel III: 2010+
 Significantly increases
quality and quantity of
capital
 Established minimum
Total Capital ratio
 Retained minimum capital
requirement, but…
 Simplistic credit-risk
model focused on
solvency risk
 Enhanced sensitivity of
credit risk measurement
(PD, EAD, LGD, M)
 Prescribed risk-weights
applied to counterparty
categories
 New operational risk
 Differentiates global
systemically important
banks to address “too
big to fail”
 New trading market risk
(Basel II.5)
 Standardized or VAR
model for market risk
added in 1996
 Adds new measures for
liquidity and leverage
 Still primarily focused on
solvency risk
 Still a work in progress
and to be phased-in
over six years, starting
2013
 Live in EU (2008) and
many countries but NOT
in the U.S.
Key Requirements of Basel III
Increases Quality and Quantity of Bank Capital
• Narrower definition for Tier I Capital
• Increase in minimum total capital requirement
• Introduce Capital Conservation Buffer & Countercyclical Capital Buffer
• Additional capital requirement for Global Systemically Important Bank (G-SIB)
Sets new Leverage Ratio Standard
• Designed to constrain leverage and supplement risk based measure with a simple
absolute measure of leverage - Tier 1 ratio of 3% total assets
Sets new Liquidity Ratios
• Liquidity Coverage Ratio (LCR)
• Net Stable Funding Ratio (NSFR)
6
Basel III Rules are Phased-in Over Time
2011
2012
2013
2014
2015
2016
2017
2018
2019
2.0%
2.0%
3.5%
4.0%
4.5%
4.5%
4.5%
4.5%
4.5%
NA
NA
NA
20%
40%
60%
80%
100%
100%
4.5%
5.5%
6.0%
6.0%
6.0%
6.0%
6.0%
Capital Framework
Minimum Common Equity (CET1)
Deductions from CET1 (1)
Minimum Tier 1 Capital
Minimum Total Capital
Capital Conservation Buffer (CCB)
Min. Total Capital + CCB
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
NA
NA
NA
NA
NA
0.625%
1.25%
1.875%
2.5%
8.0%
8.0%
8.0%
8.0%
8.0%
8.625%
Up to
0.625%
Counter Cyclical Buffer
(if triggered)
Additional Loss Absorbency for
Systematic Importance (2)
9.25%
Up to
1.25%
9.875%
Up to
1.875%
10.5%
Up to
2.5%
1–2.5%
or 3.5%
Phase In
15.5%
Maximum Total Capital for G-SIB
including Counter Cyclical Buffer
Leverage Ratio (3)
3%
3%
≥ 90%
≥ 100%
> 100%
> 100%
Parallel Run with Disclosures 2015+
Liquidity Ratio
Liquidity Coverage Ratio (LCR) (4)
Net Stable Funding Ratio (NSFR) 4)
Observation Period
≥ 60%
Observation Period
≥ 70%
≥ 80%
(1) Deferred Tax Assets (DTA), Mortgage Servicing Rights (MSRs) and equity ownership of other financial institutions is capped each at 10% of CET1 and combined at 15% of CET1;
phased out completely by 2018
(2) Additional requirement is for CET1 for G-SIBs; proposed June 25, 2011. Additional 1% is required for banks in the 2.5% category who increase their systematic importance
(3) Test run at 3% during observation period before figure set for 2018+.
(4) Proposed but not final ratio
7
This information is being provided for general awareness, and does not constitute legal or tax advice. The recipient should consult with his/her tax and legal advisors on the subject.
Basel III:
How will it change banks behaviors?
What should corporates do to mitigate the
impact?
1) Increased Capital Requirements for Loans
 Pressure on Bank Service Fees
External
Liabilities
External
Liabilities
Assets
Increase in Capital Requirements
puts Upward pressure on Required Return,
thus pushing up Banking Service Fees &
Interest Margins
Assets
Pricing increases may be as high as 50% or
more
BASEL
Capital
Other
Capital
Return on Capital =
BASEL
Capital
Other
Net Income
Risk Capital
9
Non-investment Grade & SMEs will be more
severely impacted
Increased Capital Requirements for Loans Cont’d
 Pressure on Bank Loans
Capital Framework
2019
Minimum Tier 1 Capital
6.0%
Minimum Total Capital
8.0%
Capital Conservation Buffer (CCB)
2.5%
Min. Total Capital + CCB
10.5%
Counter Cyclical Buffer
(if triggered)
Up to
2.5%
Additional Loss Absorbency for
Systematic Importance (2)
Maximum Total Capital for G-SIB
including Counter Cyclical Buffer
Capital
Adequacy =
Ratio (CAR)
10
1–2.5% or
3.5%
15.5%
Bank’s Capital
Risk Weighted Assets
New Leverage Standards sets
limitations on asset growth rate of a
bank, which requires banks to reassess
Quality of Loans and the Return on
Loans…
Banks will continue to focus on asset
distribution vs. book and hold
Given overall constraint on balance
sheet, absolute size of credit exposures
will be looked at more closely,
regardless of returns
2) New Liquidity Ratios
 Pressure on Deposits
Liquidity Coverage Ratio (LCR)
• High quality liquid assets to weather a 30-day
severe stress scenario based on specific
deposit run-off assumptions and narrow
definition of liquid assets
• Higher runoff assumptions for non-operating
deposit accounts
Net Stable Funding Ratio (NSFR)
• Evaluates longer term sustainable maturity
structure of assets and liabilities
• Will force banks towards more stable longer
term funding
11
Impact on deposit pricing…
1. Banks tend to offer more for
operating balances vs nonoperating balances
2. Corporate balances are
weighted more than FI
balances
“Liquidity Premium” world
3) Increased Capital Requirements on Derivatives
 Pressure on Interest Rate and Cross-Currency Swaps
Funding
Country
r0 = 4%
r1
7%
r2
6%
r4
10%
r3
5.5%
• Capital increases as both “default” risk capital and
“credit value adjustment” (CVA) are factored into
counterparty credit risk analysis/capital.
12
Increase in Sweeping cost tend to
make current “Fund in low cost of
capital country – Sweep to high cost
of capital regions” structure less
attractive. Alternatively, funding in
local currency might develop as a
new trend…
4) Shifting Banking Environment
 Encourage Partnership
 Increased costs associated with
compliance, risk, and controls add to an
already high cost delivery model
 Banks tend to pay more attention to
business lines outside of loans and
encourage cross-sale
 Operating scale and efficiency, and
access to deposit funding (both
currency and locale) will favor some
banks, driving others to reinvest limited
capital elsewhere
13
Banks will focus more on a smaller
number of higher-returning clients
Banks will become increasingly focused
on ancillary revenues (even more than
they already are)
There will be an Increase tension to
reduce the size of credit facilities
Banks will cease being “one stop
shopping” and will focus on core,
profitable business that is controllable
and scalable
Summary: Basel III Implication for Corporates
Banking Actions
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Corporate Suggested Actions
Decrease in Bank Credit
Availability / Increased
Capital
• Seek alternative funding from improving working
capital efficiency
• Size funding needs more accurately
New Liquidity Ratios
• Take advantage of bank’s willingness to pay
more for operational deposits
Rise in Cross-country
Swapping Costs
• Leverage local currency loans and/or working
capital efficiencies to reduce funding needs
• Shop around
Shifting Banking
Environment / Re-evaluation
of Client/Bank Relationships
• Select trustworthy provider along business lines
where the bank is committed
• Secure relationship with wallet consolidation
• Properly size credit facilities with respect to
overall available wallet
Special Topic:
Increase working capital efficiency
with alternative liquidity sources
Market Trends – Regulatory Headwinds
Recent market developments and changes in the regulatory environment have brought increasing limelight on
the treasurer’s role
New regulations

Basel III (Global)

Dodd-Frank (US)

FATCA (US)

Repeal of Regulation Q (US)

Financial Transaction Tax (EU)

MiFiD II (EU)

Solvency II (EU)

Securities Law Directive (EU)

Single Euro Payments Area (EU)

Independent Commission on Banking
(UK)

FSA liquidity regulation (UK)

CBRC new capital adequacy ratios
(China)

APRA accelerated Basel III timeline
(Australia)
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Implications
Strategy
Improve risk management:
Emphasis on visibility &
control
Monitor regulatory changes
and model impacts
Centralize Treasury
Operations
Increase cash operational
control; Manage local and
regional cash operations
within a global model
Focus on Working Capital
Management
Improve forecasting & cash
utilization
Increase return
Improve Risk Management
Funding Sources: Long Term  Short Term
Long Term Capital Structure
1
Corporate
Capital
Structure
1
Equity
2
3
Short Term Funding Requirements
Long Term Debt
Long Term Trading Partners
Corporate
Liquidity
4
Available Cash
2
CP & ST Debt
3
Asset backed securitization
Payables Processes
Supply Chain Finance
17
Sampling of Corporations Utilizing Supply Chain Finance
Corporation
Alcoa
AutoZone Inc.
Bayer
Big Lots, Inc.
Caterpillar
CNH Global N.V.
Cummins
CVS
DuPont
Electrolux
General Mills
GlaxoSmithKline
Goodyear
Johnson Controls
Kimberly Clark
Kohl’s Corp.
Lowes
Navistar
O’Reilly Automotive Inc.
Proctor and Gamble
Rolls Royce
Stanley Black & Decker, Inc.
Toro
Unilever
Wal-Mart Stores Inc.
Whirlpool Corp.
Disclosure
10-K
10-K
News Articles
News Articles
Corporate Website
News Articles
News Articles
Company Website
News Articles
News Articles
10-K
Corporate Website
10-K
Corporate Website
News Articles
10-K / Earnings Call
10-K
10-K
10-K
News Articles
News Articles
News Articles
10-K
News Articles
News Articles
10-K
Rolls Royce
http://www.rolls-royce.com/about/suppliers/supplier_finance/
“Cash flow is vital for every business and never more so than in today’s challenging
economic times. To assist our suppliers we have launched a scheme called Supplier
Finance programme.
This will inject additional funds/working capital into the external supply chain. It is an
entirely voluntary facility which will allow suppliers to receive cash early for RollsRoyce invoices, whilst Rolls-Royce continue to pay to existing terms.
It utilises facilities arranged between ourselves and Citibank, and provides a
competitive “pay as you use” source of funds.”
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Caterpillar
http://www.caterpillar.com/cda/layout?m=389975&x=7&id=3366603
“Recognizing that a manufacturer is only as strong as its supply chain, Caterpillar
facilitated a new Supply Chain Finance program in 2010 and expanded the program in
2011. As a result, suppliers, through a financial institution, can accelerate cash flow to
help their own businesses ramp up. This program is yet another example of how
Caterpillar is using its strengths to build strength.”
“Attacking the Cash Conversion Cycle: Kimberly-Clark”
Treasury & Risk Magazine – November 2010
Kimberly-Clark focused on its cash conversion cycle with the goal of reducing it by two
to three days. The cross-functional, cross-regional project worked so well that the
company actually cut the time by 15 days, says Jun Wang, assistant treasurer for
global liquidity. That translated into a $900 million reduction in working capital for 2009
and contributed to an overall improvement in return on invested capital of 160 basis
points. The $900 million was used to pay down debt, increase the pension
contribution, and invest in business and acquisition opportunities…
…Days payable were extended through a multilayered strategy that included longer
terms linked to a supply chain finance program through Citigroup that allows key
suppliers to get discounted invoices paid sooner by the bank, Wang says. The
company also signed up for Citi's electronic invoicing solution to create AP efficiencies
and reduce paperwork for both itself and its suppliers.
Ex-Im Renews Supply-Chain Guarantee for Citibank Supporting CNH
Suppliers U.S. Ex-Im News Release – April 18th, 2013
The Export-Import Bank of the United States (Ex-Im Bank) renewed a 90-percent
guarantee of a $100 million supply-chain facility for Citibank to purchase invoices that
are generated through the sales of goods and services by eligible U.S. suppliers to
CNH America LLC (CNH).
Johnson Controls
http://www.johnsoncontrols.com/content/us/en/suppliers/automotive_experience/applicati
ons/prime_revenue.html
“Johnson Controls is pleased to offer, to vendors meeting all commercial expectations,
….a supply chain finance (SCF) solution whereby suppliers can choose to be paid,
prior to invoice due date, at a discount rate based on Johnson Controls' credit rating.
We encourage suppliers to review this offering as a means to better manage their
liquidity in a flexible, cost effective way. The only fee associated is the discount paid if
early payment is requested.”
Trade Working Capital
Regulatory and accounting headwinds lead increasingly to find a source of long term capital and short term
liquidity
Shorten
Days Sales
Outstanding
(DSO)
Extend Days
Payable
Outstanding
(DPO)
Reduce
Cost of
Goods Sold
(COGS)
Capture
early pay
discounts
Minimize
collection
float
Buyer
Forecast
Cash Flows
efficiently
and
effectively
Supplier
Mitigate
concentration
risk
Stabilize
the supply
chain
Prevent
“channel
stuffing”
•
•
•
19
Gain
access to
low cost
liquidity
Buyers and suppliers often have conflicting objectives during commercial terms negotiation, with a common goal to
strengthen their relationship
A suite of products focused on Working Capital optimization can achieve all of these objectives
Only solutions that lead to mutually beneficial outcomes can attain meaningful improvements for both Buyers and Suppliers
Working Capital Benefits of Extending DPO
Sensitivity Analysis: Benefit of Terms Extension
Improving cash conversion cycle reduces the
need for CP and other Financing
Working Capital Unlocked ($MM)
DPO
30 Days
DIO
DSO
CP Requirement
30 Days
60 Days
60 Days of funding
DIO
DSO
CP Requirement
30 Days
60 Days
Reduced by 50%
DIO
DSO
CP Requirement
30 Days
60 Days
No requirement for CP
CCC = 60 Days
DPO
60 Days
CCC = 30 Days
DPO
90 Days
1 Day
5 Days
10 Days
15 Days
20 Days
30 Days
60 Days
CCC = 0 Days
 Business is now self funding
Key Assumptions:
 Available Spend: $5,000 MM
 Cost of Funding: Assumed to be 5%
20
 Any financing requirement is Zero
 Any financing cost is now paid by suppliers
Payment Mechanics – Without Supply Chain Financing
60 Payment Term
Day 10*
Buyer
Approves
invoice
Day 60
Day 59
Supplier
Supplier
Buyer
Supplier
Buyer
Payment
Instruction
Remits
funds
Bank
• Buyer approves Supplier’s
invoice
Bank
• Buyer sends Payment
Instruction to Bank
• Supplier is usually not made
aware of invoice approval
timing
*Varies based on time taken to approve an invoice and terms objectives
21
Bank
• Bank remits Payment to
Supplier
Payment Mechanics – With Supply Chain Financing
60 Payment Term
Day 10*
Buyer
Approves
invoice
Supplier
Sends future
dated Payment
Instruction
Bank
Buyer
Supplier
Request for
discount
Pending
payment
notification
• Buyer approves Supplier’s
invoice and electronically
instructs Bank to pay Supplier
on a future date, i.e. Day 60
• Supplier notified electronically
of payment from Buyer due on
Day 60
*Varies based on time taken to approve an invoice
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Day 11
Bank
Day 60
Buyer
Supplier
Settlement of
invoice
Remits
funds
• Supplier may immediately and
electronically discount the
underlying receivables to cash
without recourse, at an attractive
discount rate
• Bank remits funds to Supplier
typically via EFT or Wire for next
day settlement
Bank
• Buyer funds a disbursement
account via normal Accounts
Payable (AP) processes at
maturity
Your Suppliers’ Borrowing Cost
 Standard and Poor’s (S&P) and Moody’s credit ratings drive the cost of borrowing for
Companies
 BBB- or better are considered “Investment Grade”, below BBB- are considered “NonInvestment Grade.”
 Companies without ratings (NR) are generally smaller, privately held companies / Small to
Medium Sized Enterprises (SMEs)
Investment Grade
8%
Non-Investment Grade
60%
7%
50%
Cenovus
CNR
Husky
6%
Borrowing Cost
40%
Shell
5%
CNOOC
Statoil
Total
4%
Imperial Oil
Enbridge
Suncor
TransCanada
Encana
30%
Talisman
3%
20%
2%
10%
1%
0%
0%
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
Vendor S&P/Moody’s Credit Rating
23
Estimated Borrowing Cost by Credit Rating
B+
B
B-
CCC+
CCC
NR
Typical Spend Distribution by Credit Rating
 For most large Corporations, we find the majority of the spend is with Non-Investment Grade
or Not-Rated Suppliers
 Such companies have limited access to capital and higher borrowing costs
Borrowing Cost
Investment Grade
40%
Non-Investment Grade
7%
35%
6%
30%
5%
25%
4%
20%
3%
15%
2%
10%
1%
5%
0%
0%
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
Vendor S&P/Moody’s Credit Rating
24
Spend
BB-
B+
B
B-
CCC+
CCC
NR
Spend
8%
Typical Spend Distribution by Credit Rating
 Vast majority of spend is with Suppliers who borrow at much higher rates than most large
Buyers in Canada
 The differential is even wider for Emerging Market suppliers
Borrowing Cost
Investment Grade
40%
Non-Investment Grade
7%
35%
6%
30%
5%
25%
4%
20%
3%
15%
2%
10%
1%
5%
0%
0%
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
BB+
BB
BB-
B+
Vendor S&P/Moody’s Credit Rating
25
Spend
Estimated Borrowing Cost by Credit Rating
B
B-
CCC+
CCC
NR
Spend
8%
Thank You!
Q&A
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