Asset and Liability Management Asset Liability Management Introduction
Asset and Liability Management Asset & Liability Management Introduction © Andrew Fight 2002 Slide 1
Asset and Liability Management What is ALM about ? • Liquidity • Interest rate risk (in the main portfolio, not in trading books) • Balance sheet management © Andrew Fight 2002 Slide 2
Asset and Liability Management Balance Sheet Management • Capital • Funding § Bond issues § Deposit pricing • Portfolio Composition § Securitisation § Credit concentrations and their solution © Andrew Fight 2002 Slide 3
Asset and Liability Management ALM, business units, and relevant issues © Andrew Fight 2002 Slide 4
Asset and Liability Management Why do we need ALM ? • Maturity Transformation (banks borrow short and lend long) • Bank portfolios generate interest rate risk • Capital needs to be allocated and managed • Portfolio imbalances (eg. All retail deposits from one country) © Andrew Fight 2002 Slide 5
Asset and Liability Management Organising ALMAC The Asset and Liability Management Committee © Andrew Fight 2002 Slide 6
Asset and Liability Management The Balance Sheet, The Regulator and Bank Capital © Andrew Fight 2002 Slide 7
Asset and Liability Management Capital Adequacy Requirements • Capital Must Exceed 8% of Risk-Weighted Assets • Risk Weighted Assets calculated by applying factors (Risk Weights) to on & off-balance sheet items © Andrew Fight 2002 Slide 8
Asset and Liability Management Risk Weights © Andrew Fight 2002 Slide 9
Asset and Liability Management Examples of Capital Adequacy Calculation Example 1 Asset = $100 M GECC Bond Risk Weight = 100% Capital Required = 8% x 100% x $100 M = $8 M Example 2 Asset = $100 M Deutsche Bank Bond Risk Weight = 20% Capital Required = 8% x 20% x $100 M = $1. 6 M © Andrew Fight 2002 Slide 10
Asset and Liability Management Other Developments • BIS 1996 – Capital required for market risk • BIS 2000+ – Three New Approaches to Credit Risk – Capital needed for liquidity risk, operational risk etc. © Andrew Fight 2002 Slide 11
Asset and Liability Management Three Approaches Standardised Approach © Andrew Fight 2002 Internal Ratings-based Approaches Credit-Risk Modelling Slide 12
Asset and Liability Management Tiers of Capital • Tier 1 – Shareholders funds § Can be used to support trading and banking • Tier 2 – Perpetual, medium, long-term subordinated debt, general provisions, fixed asset revaluation reserves § Can be used to support trading and banking © Andrew Fight 2002 Slide 13
Asset and Liability Management Tiers of Capital (Continued) • Tier 3 – Short-term Subordinated Debt § Can be used to support trading activities • Aggregate Rule – Tier 2 + Tier 3 can only be used up to the level of Tier 1 © Andrew Fight 2002 Slide 14
Asset and Liability Management Regulatory vs Economic • Economic capital is not the same as regulatory capital • Regulatory calculation basically flawed • Economic capital should be used for return on capital calculations © Andrew Fight 2002 Slide 15
Asset and Liability Management ALM Decisions and Capital Concerns • Portfolio Composition • Interest Rate (and other market risks) • Long-term funding © Andrew Fight 2002 Slide 16
Asset and Liability Management Liquidity Risk • Measurement and Management © Andrew Fight 2002 Slide 17
Asset and Liability Management Liquidity Risk Measurement • Measurement – Construct a maturity ladder, and net funding requirement. • Assumptions on maturity are needed – Maturities can be contractual or expected or worstcase. © Andrew Fight 2002 Slide 18
Asset and Liability Management Assumptions for an Expected Mismatch • • Likely maturity of retail deposits Drawdowns of committed facilities Seasonality Discount to be applied to marketable securities © Andrew Fight 2002 Slide 19
Asset and Liability Management A Maturity Ladder Expected Maturity © Andrew Fight 2002 Slide 20
Asset and Liability Management Net Funding Requirement Expected Maturity © Andrew Fight 2002 Slide 21
Asset and Liability Management A Liquidity Ladder Contractual Maturity © Andrew Fight 2002 Slide 22
Asset and Liability Management Liquidity Management • Tools of Liquidity Management – Standby Facilities – Marketable Securities § Can be used as collateral for loans through repos etc. • In the last resort …… – Central Bank facilities © Andrew Fight 2002 Slide 23
Asset and Liability Management Funding Requirement Contractual Maturity © Andrew Fight 2002 Slide 24
Asset and Liability Management Types of Interest Rate Risk • Repricing Risk – Exposure to changes in the absolute level of interest rates • Yield Curve Risk • Basis Risk • Optionality © Andrew Fight 2002 Slide 25
Asset and Liability Management Interest Rate Risk • Classification and Measurement © Andrew Fight 2002 Slide 26
Asset and Liability Management Parallel Shift © Andrew Fight 2002 Slide 27
Asset and Liability Management Steepening © Andrew Fight 2002 Slide 28
Asset and Liability Management Effects of Interest Rate Risk • Net Interest Income may fall • Net Asset Value (Portfolio) Value may fall © Andrew Fight 2002 Slide 29
Asset and Liability Management Measurement Techniques – Bucket and Gap analysis – Duration § Price Value of a Basis Point – Large Exposure Reporting © Andrew Fight 2002 Slide 30
Asset and Liability Management Measurement Techniques • More Advanced Techniques – Va. R and Related Techniques § Monte Carlo Simulation § Historical Simulation – Dynamic Simulation including strategy and business changes © Andrew Fight 2002 Slide 31
Asset and Liability Management Interest Rate Derivatives © Andrew Fight 2002 Slide 32
Asset and Liability Management Interest Rate Derivatives • • • Interest rate swaps FRAs Eurodollar futures Overnight Index Swaps Caps & Floors IROs © Andrew Fight 2002 Slide 33
Asset and Liability Management Interest Rate Swap LIBOR Bank Fixed Rate © Andrew Fight 2002 Swap Provider Slide 34
Asset and Liability Management Credit Exposure Profiles for Interest Rate and Currency Swaps Exposure Currency swap Interest rate swap Time © Andrew Fight 2002 Slide 35
Asset and Liability Management Balance Sheet Management • Long-Term Funding © Andrew Fight 2002 Slide 36
Asset and Liability Management Long Term Funding - The Key Issues • • Currency, Amount, Maturity Investor concerns: Market Access Hedging: Hidden costs of credit and capital MIS © Andrew Fight 2002 Slide 37
Asset and Liability Management A Typical Long-Term Funding Process Set target, maturity, required currency Assess Proposals Appoint Paying Agent, Get tax advice, listing © Andrew Fight 2002 Appoint Lead Manager: Advises on Timing, Swaps, Documentation Syndication Sale to Investors Slide 38
Asset and Liability Management Standard Market Interest Rate Swap LIBOR Issuer 4. 90% © Andrew Fight 2002 Swap Provider Slide 39
Asset and Liability Management Interest Rate Swap for a New Issue • • 5 Year Issue 4. 75% Coupon • Issue Price 100. 00 • Fees 0. 1% © Andrew Fight 2002 LIBOR - 12. 5 BP Issuer 4. 75% Swap Provider Fees Slide 40
Asset and Liability Management Currency Swaps Sterling Principal Start Swap Provider Issuer Euro Principal Sterling Interest Exchange Issuer Maturity Issuer Euro Interest Euro Principal Swap Provider Sterling Principal © Andrew Fight 2002 Slide 41
Asset and Liability Management Balance Sheet Management • Securitisation © Andrew Fight 2002 Slide 42
Asset and Liability Management Securitisation : Key Issues • Vehicle must be bankruptcy remote • Must be off balance sheet • Credit Enhancement © Andrew Fight 2002 Slide 43
Asset and Liability Management Securitisation Examples • Mortgage pass-throughs & CMOs • Credit Card Receivables • Collateralised Loan Obligations © Andrew Fight 2002 Slide 44
Asset and Liability Management Credit Enhancement • • Overcollateralisation Tranching Reserves Credit Insurance © Andrew Fight 2002 Slide 45
Asset and Liability Management Mortgage Pass-through Mortgages Originator SPV Cash Securities Investor © Andrew Fight 2002 Slide 46
Asset and Liability Management Cashflow Details Credit Support Mortgagor Note Holder SPV Mortgage payments less servicing fee Mortgage Payments © Andrew Fight 2002 Principal Plus Interest Note Holder Servicer Collects payments Slide 47
Asset and Liability Management Tranching Principal Cashflows Time Fast Pay Tranche A © Andrew Fight 2002 Medium Pay Tranche B Slow Pay Tranche C Slide 48
Asset and Liability Management Credit Derivatives • Basic Instruments and Issues © Andrew Fight 2002 Slide 49
Asset and Liability Management Types of Credit Derivative • • Credit Default Swaps & Options Total Rate of Return Swaps Credit-Linked Notes Various Spread Products © Andrew Fight 2002 Slide 50
Asset and Liability Management Credit Default Options Fee (BP) Bank A No credit event Credit event © Andrew Fight 2002 Zero Bank B CEP Slide 51
Asset and Liability Management Total Return Swaps Total positive returns on Bond C Bank A Bank B LIBOR + Spread + Losses on Bond C (Reference credit) © Andrew Fight 2002 Slide 52
Asset and Liability Management Credit-Linked Note Non-Principal Protected Coupon Issuer (Bank B) Principal No credit event Investor (Bank A) Credit event Principal Less CEP Bond C (Reference credit) © Andrew Fight 2002 Slide 53
Asset and Liability Management Credit Derivatives and ALM • • Can reduce credit risk concentrations Can provide funding opportunities Can be used in securitisation transactions Under some circumstances, can reduce regulatory capital usage © Andrew Fight 2002 Slide 54
Asset and Liability Management A Typical CLO $100 M in loans 50 senior secured bank loans Average rating B 1 Class B $7 M Diversified by industry & obligor 12 year maturity LIBOR + 120 Baa 3 LIBOR + 275 Equity $8 M 12 Year maturity subordinated 5 Year Average Life © Andrew Fight 2002 Class A $85 M 12 year maturity LIBOR + 50 Aa 3 Slide 55
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