Term Asset-backed Security Loan Facility (TALF) (Restore credit flows to HHs and Firms through the Securitization Market)

Transcription

1 Loan Term Asset-backed Security Loan Facility (TALF) (Restore credit flows to HHs and Firms through the Securitization Market) Recession => defaults => demand for ABS => mkt dislocation credit availability & interest rates => economic slowdown Revive the Shadow Banking System : $1 trill/year in funding Borrowers Auto Originate Loans Sell Loans Receive $$ Lenders Special Purpose Vehicle Loan Pool ABS (Secured by Loan pool) ABS Loans bundled into securities Washington Maxim: Temporary solution => Permanent fixture F. I.s Hedge Funds Investment Funds ABS Auto C.C. Student Business $100 mil Fed Borrowings $92 million Risk Capital $8 million FRB-NY TALF Loans $200B to $1000 B Reserves TALF Loans Non-recourse (Fed can only seize ABS) Secured by eligible collateral (AAA) 3-yr term Interest rate = 1-mo LIBOR bps Loan-to-values and Haircuts (4-12%) Interest payable monthly Borrower has option to prepay loan ABS capital remittance must be used to pay down TALF loan

2 Chapter 9 Principles of Bank Management 1. Liquidity Management 2. Asset Management Manage credit risk - get borrowers with low default risk, paying high interest rates Buy securities with high return, low risk Diversify Manage interest-rate risk 3. Liability Management Important since 1960s Banks no longer primarily depend on deposits When see loan opportunities, borrow or issue CDs to acquire funds Manage interest-rate risk 4. Capital Adequacy Management

3 ASSET-LIABLITY MANAGEMENT The Process of planning, directing and controlling the balance sheet flows, levels, mix, and yields & cost of funds. To Achieve Financial Goals: Capital (Net Worth) Income (ROA) Member value Flexibility Growth (PCA!) Loan-to-share ratios To Control Financial Risks: Credit risk (default) Liquidity risk Interest rate risk

4 Valve/Control: 1. Interest rates 2. Loan underwriting standards Loan originations per year Inflow/Production Equilibrium Condition Inflow = Outflow Loan balance Valve/Control: 1. Contract term 2. Interest rates 3. Economy Amortization / sales Prepayments Chargeoffs per year

5 Asset-Liability Management Interest Rate Risk Interest rate risk is the potential impact of interest rate movements on an institution s net interest income and capital level. It focuses on the repricing speed of the institution s assets relative to liabilities Credit Risk Credit risk is the oldest of all financial risks. It is the danger that a borrower will simply fail to meet interest payments or repay a debt Liquidity Risk Liquidity risk is concerned with maintaining an adequate availability of funds for loan demand, deposit outflows, and expense payments in changing interest rate environments

6 UWCU Balance Sheet Assets Liabilities + NW Cash (7.5%) Deposits (88%) Securitization market freeze up Checking Deposits (15%) Investments (6%) Regular Savings (15%) 1. Write down security to market value MMA (29%) Loans (82%) CDs (25%) Consumer (20%) IRAs (4%) Mortgage (46%) Student (16%) 5. Sell off assets Borrowings (2.5%) Building (4.5%) Net Worth (9.5%) 6. asset prices Downward spiral to widespread insolvency to pay off loans YOA - COF = NIM Liquidity Crisis 4. Lenders refuse to rollover loans 2. net worth + Fee/Other Income - Operating Expense - PLL = Net Income 3. probability of insolvency * Required ROA = Asset Growth Rate x Capital Ratio (dependent variable) (choice variable) (current)

7 Accounting Review Basic Accounting Equation Assets = Liabilities + Equity (A = L + E) Extended Accounting Equation Assets + Expenses = Liabilities + Equity + Income Both sides of these equations must be equal (balance). (A + Exp. = L + E + Inc.) Double Entry Bookkeeping System: Every debit transaction must have a corresponding credit transaction and vice versa. Debits and credits are the 2 aspects of every transaction. Debits and credits form 2 opposite aspects/sides of every financial transactions. Debit (Dr) is the left side of a ledger account. From latin, debere (to owe). Credit (Cr) is the right side of a ledger account. From latin, credere (to entrust). 5 Types of Accounts Increase Decrease Assets Debit Credit Liabilities Credit Debit Equity/Capital Credit Debit Income Credit Debit Expense Debit Credit Debits Dr Assets Credits CR Liabilities Debits Dr Credits Cr

8 Example1: Person deposits cash into bank checking account Bank Assets Liabilities + E Person Assets Liabilities + E Debits Credits Debits Credits Debits Credits Reserves +100 Deposits +100 Cash -100 Deposits +100 For every transaction, total debits must be equal to the total credits and therefore balance. Value of Debits = Value of Credits. Example 2: Investment Company buys a $500,000 condo. Investment Co. Assets Liabilities + E Debits Credits Land +500,000 Debits Credits Debt +500,000 Bank Assets Debits Credits Loans +500,000 Cash -500,000 Liabilities + E To balance the accounting equation ( A = L + E ) the corresponding liability account is credited.

9 Transaction Account Debit (dr) Credit (cr) 1. Investment Co. buys $500,000 condo. 2. Investment Co. pays salaries with cash. 3. Investment Co. receives $1,000 condo rent. Land (asset) Debt (liability) Salary (expense) Bank Account (asset) Bank Account (asset) Rent (revenue) Total (dr) Total (cr) Journal Form $500,000 $3,000 $1,000 $504,000 $500,000 $3,000 $1,000 $504,000 Totals show net effect on accounting equation and double-entry principle where transactions are balanced. Credit transactions are indented in the Account column. Extended Accounting Equation A + Exp = L + E + Inc Transaction 1: $500,000 (dr) $500,000 (cr) Transaction 2: -$3,000 (cr) $3,000 (dr) Transaction 3: $1,000 (dr) $1,000 (cr)

10 Repurchase Agreements (Repo) (Sale and repurchase of securities agreement) Repo = Cash Transaction + Forward Contract (Loan origination) (Loan repayment) (Spot price) (Forward price) (Near leg) (Far leg) (Settlement date) Fed MMMFs Bank T-Bill Buyer/Lender Fed T-Bill $ Collateral: T-Bills/Bonds Reverse Repo: Buyer/Lender Repo: Seller/Borrower $ Repo: Fed adds reserves Reverse Repo: Fed initially drains reserves Adds reserves back later Used to target i ff Repos began in 1917 by Fed to lend to banks $5 Trillion Repo market today Secured cash loan Legal transfer of security to lender Repurchase price > Original price (gap = interest) 1-7 day term typically, up to 2 years Typically over collateralized to mitigate credit risk Fed describes transaction from the counterparty s viewpoint, rather than from their own.

11 Assume Required Reserve Ratio (RRR) = 20% Calculate maximum deposit outflow Reserve Outflow Balance Sheet Deposit Outflow -20,000 RR = 20,000 ER = 20,000 Chk Dep = 100,000-20,000-4,000 RR = 16,000 ER = 4,000 Chk Dep = 80,000-4, RR = 15,200 ER = 800 Chk Dep = 76, RR = 15,040 ER = 160 Chk Dep = 75, RR = 15,008 ER = 32 Chk Dep = 75, Sum = 25,000 RR = 15,001 ER = 7 RR = 15,000 ER = 0 Chk Dep = 75,008 Chk Dep = 75,000-7 Sum = 25,000 Maximum deposit outflow = 20,000 [ ] = ER [1 + x + x 2 + x 3 +..], where x = RRR = 0.2 = ER [1/(1-x)] = 20,000 * 1.25 = 25,000

12 Assume Required Reserve Ratio (r) = 20% Calculate maximum deposit outflow, X What we know: R 1 = RR 1 + ER 1 R = V.C. + F.D. DR = DD = X RR = rd Balance Sheet RR = $20,000 ER = $20,000 Chk Dep = $100,000 R after deposit outflow X: R 2 = 40,000 X RR after deposit outflow X: RR 2 = 0.20 * (100,000 X) ER after deposit outflow X: ER 2 = 0 R 2 = RR 2 + ER 2 40,000 X = 0.20 * (100,000 X) ,000 5X = 100,000 X 25,000 = X DR = DRR + DER 25,000 = 5, ,000

13 Assume a new checkable deposit, DD, leads to: Vault cash, VC, increases $2 million (DVC = 2) Excess reserves, ER, increase $9 million (DER = 9) Required Reserve Ratio, r = 10% Calculate the increase in Fed Deposits, DFD What we know: RR = rd R = RR + ER R = VC + FD DR = DD RR = rd Balance Sheet R = RR + ER R = VC + FD DR = DD D R = RR + ER DR = DRR + DER (convert to changes) DD = r DD + DER (equation substitution) DD = 0.10 DD + 9 (r = 0.10 and DER = 9) DD = 10 R = VC + FD DR = DVC + DFD (convert to changes) DD = DVC + DFD (equation substitution) 10 = 2 + DFD (DD = 10 and DVC = 2) 8 = DFD DR = 10 D RR = 1 D ER = 9 D VC = 2 D FD = 8 Balance Sheet DD = 10 Regulatory Allocation Location Allocation

14 A situation where 1 party has more info than the other party Adverse Selection potential bad credit risks are the ones who most actively seek out loans Screening process Asymmetric Information 2 types Moral Hazard the lender runs the risk that the borrower will engage in risky activities that make it less likely that the loan will be paid back Monitoring process Loan applicants Good C.R. The business of banking is the business of collecting information Approve Performing Bad C.R. Deny Stopping bad credit risks from becoming borrowers Loan department Loan signing Non-performing date Stopping borrowers from becoming bad credit risks Collections department

15 Inflated Non-verified Income Total Debt Expense Gross Income Housing Expense Gross Income Income Ratios (Financial Capabilities) 65% 36% 35% 28% Marginal borrower is being denied Loan Approval Zone 2007 Loan Approval Zone 2005 False Premise: Home prices always rise So default risk is low 3-Dimensional Mortgage Loan Underwriting 3 Cs of Lending 1. Collateral 2. Capacity 3. Character Loan-to-Value Ratios (Physical Security) % 100% Inflated Appraisals Credit Scores (Credit Characteristics) Mortgage Crisis: Lending to high-risk borrowers large amounts of money that they could not afford

16 Loan Loss and Credit Spreads Estimates Risk-Based Pricing Guidelines for 60 mo. Direct Auto Loans FICO Score Ranges Credit Ratings Narrow FICO Ranges Life-of-Loan Default Rates Estimated Severity Loss Est. Loss Factors (NCOs) M aximum LT Vs o ver NADA R etail 2.0 Year Pricing Spreads Total CMT on Spreads Credit Servicing Net Loan 5-Mar mo. Auto Loan Rates 720+ A+ 1.5% 10% 0.15% 110% 0.15% 0.75% 1.63% 2.53% 0.29% 2.82% A 2.5% 15% 0.38% 110% 0.38% 0.75% 1.63% 2.76% 0.29% 3.05% B+ 5.0% 20% 1.00% 100% 1.00% 1.00% 1.63% 3.63% 0.29% 3.92% B 7.0% 20% 1.40% 100% 1.50% 1.00% 1.63% 4.13% 0.29% 4.42% C+ 10.0% 25% 2.50% 95% 2.50% 1.25% 1.63% 5.38% 0.29% 5.67% C 15.0% 25% 3.75% 95% 3.75% 1.25% 1.63% 6.63% 0.29% 6.92% D+ 18.0% 30% 5.40% 90% 5.50% 1.50% 1.63% 8.63% 0.29% 8.92% D 21.0% 30% 6.30% 90% 6.25% 1.50% 1.63% 9.38% 0.29% 9.67% E+ 25.0% 35% 8.75% 85% 8.75% 1.75% 1.63% 12.13% 0.29% 12.42% E 30.0% 35% 10.50% 85% 10.50% 1.75% 1.63% 13.88% 0.29% 14.17% 540 < Subprime 45.0% 40% 18.00% 75% 18.00% 2.00% 1.63% 21.63% 0.29% >18% Refer: NCUA Risk Alert # 05-RISK-01 and LTCU # 04-CU-13 Narrow FICO Ranges Note: Net loan spreads on indirect auto loans may be 25bp to 75bp less than on direct loans after upfront fees and dealer reserves. FICO Score Ranges Credit Ratings Wide FICO Ranges Life-of-Loan Default Rates Estimated Loss Factors Est.Loan Losses (NCOs) M aximum LT Vs o ver NADA R etail Wide FICO Ranges 2.0 Year Pricing Spreads Total CMT on Spreads Credit Servicing Net Loan 5-Mar mo. Auto Loan Rates 740+ A+ 1.0% 10.0% 0.10% 110% 0.10% 0.75% 1.63% 2.48% 0.29% 2.77% A 2.0% 12.5% 0.25% 110% 0.25% 0.75% 1.63% 2.63% 0.29% 2.92% B 6.0% 20.0% 1.20% 100% 1.25% 1.00% 1.63% 3.88% 0.29% 4.17% C 12.5% 25.0% 3.13% 95% 3.25% 1.25% 1.63% 6.13% 0.29% 6.42% D 19.5% 30.0% 5.85% 90% 6.00% 1.50% 1.63% 9.13% 0.29% 9.42% E 27.5% 35.0% 9.63% 85% 9.75% 1.75% 1.63% 13.13% 0.29% 13.42% 540 < Subprime 45.0% 40.0% 18.00% 75% 18.00% 2.00% 1.63% 21.63% 0.29% >18% Note: Higher servicing costs w ere applied to low er grades of paper.

17 Capital-to-Assets Growth Rate Analysis The growth rate of a ratio is the difference between numerator and denominator growth rates, (for small growth rates). %D (C/A) = DC/C DA/A 5% 0.10 = 10 ========> 10.5 = % 2% 2% = 5% - 3% If (ROE) DC/C = DA/A Then %D (C/A) = 0 If DC/C = DA/A (multiply both sides by C/A) Then ROA = DA/A x C/A

18 Return on Equity Decomposition ROE = Asset Growth Speed Limit (given constant Capital-to-Asset ratio) Return on Equity Leverage Return on Assets R E A E R A A E R GR GR A R E = Return (net income) = Equity (reserves + undivided earnings) Profit Margin A = Assets GR = Gross Revenues (interest revenue + noninterest revenue) Asset Utilization Banks Return on Equity (by Asset Size) < $500 Million $500-$2,000 Million > $2,000 Million

19 16 Banks Equity Multiplier (Leverage) (Assets to Equity) (by Asset Size) < $500 Million $500-$2,000 Million > $2,000 Million Banks Return on Assets (basis points) (by Asset Size) < $500 Million $500-$2,000 Million > $2,000 Million

20 Banks Profit Margin (Net Income to Gross Revenues) (by Asset Size) < $500 Million $500-$2,000 Million > $2,000 Million Banks Asset Utilization (Gross Revenues to Assets) (by Asset Size) < $500 Million $500-$2,000 Million > $2,000 Million

21 The Virtuous Cycle of Banking Faster Asset Growth Higher Return on Equity ROE Self-reinforcing spiral Feedback Loop Economies of Scale Higher Return on Assets ROA Higher Profit Margin

22 Percent Credit Union Asset Growth (by Asset size) < $20 mil $20-$50 $50-$100 $100- $250 $250- $500 $500-$1 bil >$1 bil

23 Basis Points Credit Union Operating-Expense-to-Assets (by Asset size) < $20 mi l $20-$50 $50-$100 $100-$250 $250-$500 $500-$1 bi l >$1 bi l

24 Percent 25% Credit Union Profit Margin (by Asset size) 20% % 20.6% 15% 13.3% 13.3% 16.6% 15.7% 10% 9.8% 8.9% 10.1% 11.5% 7.1% 5% 5.4% 1.1% 2.4% 0% < $20 mi l $20-$50 $50-$100 $100-$250 $250-$500 $500-$1 bi l >$1 bi l

25 Basis Points Credit Union Return on Assets (by Asset size) < $20 mil $20-$50 $50-$100 $100- $250 $250- $500 $500-$1 bil >$1 bil

26 Percent Credit Union Return on Equity (by Asset size) < $20 mil $20-$50 $50-$100 $100- $ $250- $500 $500-$1 bil >$1 bil

27 Econ 330 Chapter 9 Homework Due Friday, October 21 in Discussion Chapter 9 Questions & Applied Problems 3, 7, 8, 9, 11, 16, 19, 21, 23, 24, 25