managing bank risk

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

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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?

Query to Bank

Credit Rating Trends

Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Oct 2012

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- <=BB+

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• Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity.• Source: Bloomberg Finance 4


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Risks to the University

• Financial– Loss of Principal– Insufficient Liquidity– Access to Credit Markets

• Operational • Opportunity Cost

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Cash & Investment Exposure

Investments

• Principal Risk• Diminished

Market Value• Loss of Credit

Enhancement• Liquidity• Opportunity Cost• Custody

Cash

• Deposit Balances

• Liquidity• Investment

Sweeps

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Investment Custody

“Your Purchasing Card is fine. I’m just checking that your bank hasn’t expired!”

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Operational Risk

• Purchasing Card• Merchant Card Processing• Campus Card• Payroll Card• On Campus Branch/ATM

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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

Letter of Credit Provider Ratings

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as of October 2012

• 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

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Hierarchy of Credit

Bank Credit Quality

Swaps

Lines of Credit

Direct Placements


A

A-/A3

BBB/Baa

A+/A1

AAA/Aaa

AA+/Aa1

AA/Aa

AA-/Aa3

Bank Credit Quality

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Hierarchy of Credit

Bank Credit Quality

Swaps

A

A-/A3

BBB/Baa

A+/A1 Lines of Credit

Direct Placements


AAA/Aaa

AA+/Aa1

AA/Aa

AA-/Aa3

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Hierarchy of Credit

Bank Credit Quality

Swaps


Lines of Credit

Direct Placements

A

A-/A3

BBB/Baa

A+/A1

AAA/Aaa

AA+/Aa1

AA/Aa

AA-/Aa3

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Hierarchy of Credit

Bank Credit Quality


Swaps

Lines of Credit

Direct Placements

A

A-/A3

BBB/Baa

A+/A1

AAA/Aaa

AA+/Aa1

AA/Aa

AA-/Aa3

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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

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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 environmentSource: 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)

23“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

Bank Risk Matrix - Debt

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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Long Term Debt Rating

Parent Rating

Bank Rating

Debt Exposure

Swap Counterparty

Bond Trustee

Line of CreditLiquidity and Letters of Credit

Remarketing Agent

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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Cash and Investments Deposit Accounts Savings Accounts Repurchase Agreements Money Market Funds

Commercial Paper and Corporate Notes Foundation Endowment Security Custody

Securities Lending

Bank Risk Matrix - Investment

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Treasury Relationship Matrix Bank 1 Bank 2 Bank 3 Bank 4 Bank 5Operations

Banking Services

Payroll Card

Merchant Card Travel & Entertainment Card

Integrated Payables

On Grounds Branch/ATM

Bank Risk Matrix - Operations

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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. Adopt a Risk Mgmt. Approach2. Identify Risk Events3. Score Risks4. Develop Risk Response5. 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 EventsRisk

CategoriesStrategic, Operating,

Compliance, Reporting Treasury Objective Risk (threat or opportunity)

Strategic Optimize Cash Operations Undefined Risk Tolerance

Strategic Optimize Returns on Financial AssetsMismatch between asset and liability portfolios

Operating Optimize Cash OperationsThe impact of a Reduction in Operating Budget Sources

Operating Optimize Cash Operations Cash Forecast Inaccuracy

OperatingProvide Effective Solutions for Customers

Risk of insufficient debt capacity

ReportingFacilitate Efficient and Cost Effective Access 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 Risk (threat or opportunity)

Likelihood Impact

Total Score

Velocity

(L*I)

StrategicOptimize Returns on Financial Assets

Counterparty underperformance risk

2 4 8 3

Operating Optimize Cash OperationsCounterparty Relationship Team Risk

2 3 6 3

StrategicFacilitate Efficient and Cost Effective Access to Capital

Inadequate liquidity counterparty diversity

2 3 6 3

Operating Optimize Cash OperationsCash Operations Counterparty Failure

1 5 5 5

Operating Optimize Cash OperationsCounterparty Credit Risk - Deposits

1 5 5 5

ComplianceOptimize Returns on Financial Assets Counterparty Fraud 1 5 5 5

ComplianceOptimize Returns on Financial AssetsPoor counterparty internal controls

1 5 5 5

Strategic Optimize Returns on Financial Assets Counterparty key person risk 2 2 4 3

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4. Develop Risk Response

• Retention• Insurance• Avoidance• Mitigation

5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Debt (Pre-2008)

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Treasury Relationship Matrix

Bank of America

Bank of New

York/MellonGoldman

SachsJPMorgan

ChaseMorgan 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 $50 million

Bond Trustee X

Line of Credit $250 million

Liquidity and Letters of Credit

Remarketing Agent$300 million

CP$82 million

VRDB’s

5. Measure and Monitor Risk U.Va. Bank Risk Matrix - Debt

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Bank of America/

Merrill Lynch

Bank of New

York/MellonGoldman

SachsJPMorgan

ChaseMorgan Stanley

Lehman Bros. U.S. Bank Wells Fargo

Long Term Debt Rating

Parent Rating A-/Baa2 A+/Aa3 A-/A3 A/A2 A-/Baa1 A+/Aa3 A+/A2

Bank Rating A/A3 AA-/Aa1 A /A2 A+/Aa3 A/A3 AA-/Aa2 AA-/Aa3

Debt Exposure

Swap Counterparty $50 million $50 million

Bond Trustee X

Line of Credit $100 million $50 million $100 million

Liquidity and Letters of Credit

Remarketing Agent$300 million

CP (1/2)$300 million

CP (1/2)$78 million

2003A

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Bank of America/

Merrill Lynch

Bank of New York/

MellonGoldman

SachsJPMorgan

ChaseMorgan Stanley

SunTrust Bank U.S. Bank Wells Fargo

Cash and Investments Deposit Accounts X Savings Accounts Repurchase Agreements Money Market Funds Commercial Paper and Corporate Notes Foundation Endowment

Security Custody$300 million

Portfolio

5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments (Pre-2008)

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Bank of America/

Merrill Lynch

Bank of New York/

MellonGoldman

SachsJPMorgan

ChaseMorgan Stanley


Cash and Investments Deposit Accounts X Savings Accounts Repurchase Agreements Money Market Funds * $390,000 $640,000 $540,000 Commercial Paper and Corporate Notes Foundation Endowment

Security Custody$200 million

Portfolio

$100 million Portfolio & PFM Funds

5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments

* Pro-Rata Share of Mutual Fund Holdings

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Bank of America/

Merrill Lynch

Bank of New York/

MellonGoldman

SachsJPMorgan

ChaseMorgan Stanley


Operations

Banking Services X

Payroll Card X

Merchant Card X X Travel & Entertainment Card X

Integrated Payables X

On Grounds Branch/ATM X X X

5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Operations (Pre-2008)

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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

QUESTIONS?

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Contact Information

Barbara Fava, PFM Asset Management [email protected]

June Matte, Public Financial [email protected]

Jim Matteo, University of [email protected]

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PFM DisclosuresThe 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.

managing bank risk

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