Linking: Liquidity Risk & Credit Portfolio Management

Transcription

1 Annual Fall Conference November 18-19, 2014 Philadelphia, PA Linking: Liquidity Risk & Credit Portfolio Management Randy Clyde MUFG Union Bank Head of Portfolio Analytics & Strategy: Investment Portfolio / Treasury Matthieu Royer Credit Agricole CIB Head of ALM & CPM for the Americas

2 Linking: Liquidity Risk & Credit Portfolio Management November

3 Liquidity Risk Management Part 1: Protect against Liquidity Shortfalls. Diversify Funding Sources NSFR Net Stable Funding Ratio: Regulatory Metric (Now Final) Part 2: Prepare contingency measures to counteract Liquidity Squeeze. Hold High Quality Liquid Assets ( HQLAs) as a Liquidity Reserve LCR Liquidity Coverage Ratio: Regulatory Metric (Currently Deployed) 3

4 Presentation Map 4

5 Presentation Map (observe) REGULATION REVIEW (Liquidity) (orient) INTERPRETATION Investigate how LRM influences CPM and vice-a-versa (decide) STRATEGY Explore potential CPM role wrt to LRM side-by-side with Capital Management (act) EXECUTION (Discussion??? ) We will be interested to hear your stories in later meetings 5

6 (observe) REGULATION REVIEW (Liquidity) 6

7 Liquidity Regulation Timeline Past Feb 2013 B3 Final - US Feb 2014 EPS Final TODAY Oct 2014 LCR Final Nov 2014 NSFR Final 7

8 Liquidity Regulation Timeline Going forward Jan 2015 Beg. Full LCR Reporting 80% Jun 2015 Beg. Partial Modified LCR Reporting Jan 2016 Beg. Full LCR Reporting 2017 Beg. CLAR?? 8

9 Basel III Liquidity: Target model Two minimum standard ratios designed as a framework for liquidity risk supervision. Liquidity Coverage Ratio Net Stable Funding ratio Ratio designed to ensure that a bank maintains an adequate level of unencumbered, high-quality assets that can be converted into cash to meet its liquidity needs for a 30-day time horizon under an extreme liquidity stress scenario (name and market crisis) Stock of high-quality liquid assets Total net cash outflows (under stress) over the next 30 calendar days 100% Ratio designed to guarantee medium and long-term funding of the assets over a one-year time horizon. Non liquid assets, loans with remaining maturity above 1Y, 50% of loans with maturity under 1Y and 5% of OBS commitments should be covered by long term funding (> 1Y) or stable resources. Capital + Liabilities>1Year +Stable deposits Required amount of stable funding 100% 9 strengthened by a set of common metrics, referred to as «monitoring tools» Contractual maturity mismatch (to enable supervisors to build a market-wide view), Concentration of funding (to identify those sources of funding that are of such significance that withdrawal of this funding could trigger liquidity problems), Available unencumbered assets, Market-related monitoring tools

10 Anticipated Balance Sheet rebalancing impacts Assets Liabilities Higher maintenance of low yielding cash Cash Retail deposits Fight for deposits More liquid assets increasing negative carry Crowding out of nonsovereign issuers De-leveraging and reduction of credit supply to the real economy Liquid Assets Less Liquid Assets Loans Wholesale Funding Long-term Debt Capital Impact on interbank balances More supply / less demand Financial industry no longer invests Dilution of returns New regulation will impact pricing and lead to a gap between economic and regulatory funding costs 10

11 Decreasing probability but increasing severity of event Scope of stress testing Stress-testing framework Types Example Analysis Extreme Risk due to high-impact of extremely-low-probability unknown unknowns Meteorite shower on earth No analysis can capture this effect New uncertainties Significant increase in risk (scope & depth) due to a downturn Risk due to low-probability highimpact (incl. black swan) In 2007, from all major investment banks and rating agencies, only 1 analyst anticipated and factored in as a possible scenario oil prices rising above $80/bbl for the year; for others it was a complete unexpected shock. Increased volatility of PD and LGD distribution for segments of portfolio not affected by stress Impact on Liquidity Change of institution rating (CDS price, cost of capital, etc) Anticipated scenarios Increase in risk due to a downturn. Risk due to low-probability lowimpact known unknowns Business-as-usual Risk due to high-probability known-unknowns Chinese demand destruction leading to a collapse of basic material prices Decline in US consumption levels impacting export-oriented industries in developing countries Scenario analysis comprising macro-economic, industry, financial market, regulatory/political scenarios VaR / Credit VaR analyses 11

12 Systemic Risk and Concentrations What is systemic risk New equilibrium below full production Disruption of access to credit Punishing the system, not the firm Domino Risk Modeling Stressed firms sell assets (adjust balance sheet) Contagion I - Market (Liquidity) failure, firms sell new assets and stress new markets Contagion II - Market panic and there are runs on markets Hysteresis - Long term freezing of markets 12

13 Probability of the Event Predicting Fire Sales Leverage within the System Liquidity Capacity Velocity, depth of trading Capacity for bargain hunting Linkages Book Correlation Loss Distribution Systemic Risk and Concentrations - Modeling Black Swan Tail events are rare very little data Typically strong model assumptions Liquidity Failures: Can t hedge; No replicating portfolios; Mean & Variance; Game Theory Scenario Analysis: Linkages rights, obligations (Not Netting!); Granular Macro Economics; Understanding Domino Risk 13

14 (orient) INTERPRETATION How will LRM influence CPM and vice-a-versa? 14

15 Losses Asset Performance Determines Capital Requirement Income Statement Balance Sheet Cash Flow Statement Revenue Expenses Income Loans Leases Securities Deposits Debt Equity 13% Tier 1 Capital + ALLL/OTTI (11% + 2% = 13%) 3% 15

16 Loan Loss Distribution Distribution of Losses Expected Loss (50th Percentile) 99.9th Percentile Single loss Estimate zero Unexpected Loss ~ Risk Based Capital Total Loss 16 Range of Loss Estimates 16

17 CPM Perspective Macro View (50,000 ft) Micro View (500 ft) (1,000 ft) 17 Bank Portfolio

18 Great Depression Saving & Loan Crisis s OPEC Oil Embargo 1970s Japanese Banking Crisis 1990s Mexican Banking Crisis 1994 Russian Default & LTCM Crisis 1998 Credit Frauds 2002 Great Recession History repeats itself Credit & and sometimes Liquidity Crises are likely to happen again European Credit Crises? 18

19 Losses Net Cash Outflow Stress Testing Determines Liquidity / Funding Profile Income Statement Balance Sheet Cash Flow Statement Revenue Expenses Loans Leases Securities Deposits Debt Stress Testing LCR EPS Income Equity 13% Tier 1 Capital + ALLL/OTTI (11% + 2% = 13%) 3% 19

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21 Losses Asset Performance Determines Capital Requirement Income Statement Balance Sheet Cash Flow Statement Revenue Expenses Income Loans Leases Securities Deposits Debt Equity 13% Tier 1 Capital + ALLL/OTTI (11% + 2% = 13%) 3% 21

22 Integration of Credit Portfolio & Liquidity Risk PERFORMANCE METRICS + Asset Yield - Expected Asset Loss ( EL ) - Capital Cost Cost of Equity Capital Funding - Funds Transfer Pricing ( FTP ) Cost of Liability Funding Credit Risk Liquidity Risk - Activity-based Costs = Economic Profit 22

23 (decide) STRATEGY Explore potential CPM role wrt to LRM side-by-side with CPM 23

24 How / Where is Liquidity Risk Management incorporated into Risk-Adjusted Profitability Measures MARGIN FEES Risk-free investment of allocated capital net of hedging costs (revised on annual basis) Liquidity Charges (Function of nature (on- BS / off-bs) and maturity of transaction) EAD x PD x LGD (Time horizon used for PD depends on the calculation horizon) Cost-to-Income Ratio or Fixed & Variable Costs Function of the Product RAROC = Transaction revenues - Liquidity cost - Income from + Allocated Capital Expected Loss Operating cost x (1 Tax Rate) Core Tier 1 allocated Economic Capital - All parameters in Net Present Value Economic Capital allocated to the transaction: Allocated Capital = Capital for Credit Risk + Capital for Operational Risk ( Unexpected Losses computed with internal portfolio models or Regulatory) Institution-wide Tax rate based on estimation of annual tax rate for the current year Key inputs for Credit Risk: Rating LGD EAD Avg MATURITY EVA = ( Transaction revenues Income from Allocated Capital Liquidity cost Expected Loss Operating cost x (1 Tax Rate) ) - WACC [ Weighted Average Cost of Capital= Core Tier 1 allocated Economic Capital x Target Raroc ] 24

25 How is CPM impacted Profitability Management Ability to centrally control ROE, RAROC Control cost of funds/risk Set targets for interest income and fee-based income Product Pricing Support Incorporate risk-returnbased product pricing framework Price products based on market (or target) benchmarks Use as basis for differential product pricing What are your CPM Objectives Liquidity Management Net liquidity across business units Fund liquidity mismatches at an optimal cost Centralize the deployment of surplus liquidity Management of Liquidity Buffer Balance sheet Management Manage structural liquidity mismatches (ie. borrowing short to lend long) Transfer interest rate and liquidity risk to a central unit Re-allocate capital based on risk-weighted or economic capital performance parameters

26 CPM roles: HQLA book direct involvement / management should credit risk be managed / by whom Deposit and depositor risk how are deposits incorporated in risk decisions impact (if any) on credit risk hedging Liquidity Risk Management Strategic positioning Assessment / Measurement Operational management Control / monitoring Tactical shifts 26

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28 ER 28

29 (act) EXECUTE 29

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33 NOTES & potential slides 33

34 Presentation Objectives?? not part of presentation Inform CPM Group of Liquidity Risk Management Status Explore linkage between CPM and LRM Investigate how LRM influences CPM and vice-a-versa Presentation: Key Questions (Potential) Should CPM have involvement with Liquidity Risk Management ( LRM )? What is the state of LRM currently? Where is it headed? (e.g. 3yr. timeline) Can the CPM performance framework (i.e. Return on Risk Capital) incorporate LRM? What quantitative framework will LRM require? And how might the CPM quantitative framework coincide with it? How will B3 (LCR & NSFR) and EPS (Liquidity Stress Testing) affect CPM? How will new liquidity requirements (including metrics, buffers, and limits for both) affect the management of credit portfolios? 34

35 35 Liquidity Regulation Timeline

36 36 LCR Roll-out Timeline