Stress Testing and Liquidity Analysis

Transcription

1 Stress Testing and Liquidity Analysis Liquidity risk analysis overview Understanding portfolio effect on liquidity Margin calls and market drivers Counterparty default and downgrade, and Corporate fraud, other events Surviving a liquidity shock Measuring high quality liquid assets Stress models, and Liquidity planning 1

2 Managing Risk Market Risk = change in customer costs due to exposure to market prices (e.g., gas prices increase, cost to generate increase) Market (Price) Operational Liquidity Risk = accelerated payments to counterparties when the price the utility agreed to pay is higher than market (e.g., purchased gas at $5 and now market is $4, so the counterparty wants collateral of $1) Business (Liquidity) Risk Credit Risk = potential increase in customer costs due to counterparty not delivering commodity at agreed to price that is lower than market (e.g., sold gas to PG&E at $4 and now market is $5, so if the counterparty defaults, costs are higher by $1) External (Credit) Commodity risk encompasses all risk categories 2

3 The Liquidity Spiral Asset sales, or bankruptcy Bad News Margin calls, or liquidity withdrawn Increased liquidity demand Counterparty limits, or debt covenants adv. impacted Flatten or eliminate positions Downgrade formal, or informal 3

4 Relationship Among Risks Market and Credit risk move together because successful hedging of market risk results in exposure to counterparty performance Market Prices Market Position Market Risk Hedge Credit Risk Business Liquidity Risk Hedge Purchase Price Business Liquidity Risk is different from Market Liquidity Risk, which is the risk that an asset or position cannot be liquidated in a reasonable time to avoid substantial losses Business Liquidity risk moves in the opposite direction and is the result of the accelerated realization of a loss with a counterparty that requires collateral 4

5 , Facilitates and Business Liquidity Risk Business Liquidity Risk is the risk that the company has insufficient cash or credit facilities to meet both working capital and collateral requirements The risk is a function of both sufficient and symmetrical sources and uses of collateral Sources Uses Cash from Ops Credit Facilities Cash held Cash Posted s Posted Working Capital Credit Lines 5

6 Links to Markets Y$/Unit Marke et Price Sale Contract Out-of-the-Money Post -X$ 0 PURCHASE Contract In-the-Money Receive +X$ PURCHASE Contract Out-of-the-Money Post Sale Contract In-the-Money Receive -Y$/Unit 6

7 Balancing Low Base Position Hedged Position Position Purchase Oil Hedge Sell Oil Counterparties 2 Co1 Cash Co 2 Co 3 Cash Cash Posts to Receives from Sensitivity to Market Price Posts to Receives from 7

8 Balancing Low Base Position Hedged Position Purchase Sale Cash Letter of Line of Credit Credit () Product Load Serving Hedge Buy Electricity Counterparties 1 Co1 Cash Co 2 None Co 3 Receives but no cash from Sensitivity to Market Price Posts to 8

9 Balancing Low Base Position Hedged Position Position Purchase Coal Hedge Sell Coal Counterparties 2 Co1 Cash or OR Co 2 Co 3 Posts to Receives from Sensitivity to Market Price Posts to Receives from 9

10 Balancing Low Base Position Hedged Position Position Buy Electricity Hedge Sell Electricity Counterparties 2 Co1 Limit then Cash Co 2 Co 3 Limit then Limit then Posts to Receives from Sensitivity to Market Price Posts to Receives from 10

11 Balancing Low Base Position Hedged Position Position Buy Electricity Hedge Sell Gas Counterparties 2 Co1 Cash or OR Co 2 Co 3 Cash Posts to Receives from Sensitivity to Market Price Posts to Receives from 11

12 Asymmetry Base Position Hedged Position Exchange Low Liquidity Risk OR High OR Purchase - Long Sale - Short Natural Gas Coal Oil Electricity Line of Credit Cash Letter of Credit () 12

13 Consolidated Picture Symmetrical of Hedged Position Symmetrical hedged position neutralizes market and liquidity risk Proprietary Traders Asymmetrical of Unhedged or Asset hedged Position Market spikes against position create significant liquidity demand Asymmetrical Hedged or Asset Position or Cross Commodity Positions Asymmetrical collateral of hedged position creates liquidity drains despite direction of market moves Asymmetrical collateral with opposite commodity asset hedges can have similar results Asset Managers 13

14 Liquidity Crisis Bad news triggers liquidity crisis Rating downgrade accelerates the crisis 14

15 Case Study: Williams Corporation Enron's bankruptcy 12/5/2001 S&P place Williams on a negative credit watch 5/2/2002 S&P lowered Williams' rating to BBB S&P downgraded it to BB+, then B+ two days later 2/1/2002 6/1/2002 7/23/ Oct Nov Dec Jan 2002 Feb Mar Apr May Jun Jul /16/2001 S&P:BBB to BBB+ Telecommunication industry crashed 1/30/2002 Revise downward its earnings forecast for the year Communications company filed bankruptcy 4/22/2002 $800 Million sudden increase in liquidity needs due to downgrade to below investment grade 15

16 Liquidity Crises at Energy Traders 16

17 Liquidity Crisis Triggers Profitability declined (El Paso,2002) Internal Acquisition had negative effect on coverage ratio ( UtiliCorp,2002) Assumed large debt from subsidiary, potential needs for high liquidity demands (Williams,2001) Enron Fraud, additional scrutiny over the debt size;( Williams, El Paso, Mirant,2002) External Allegation of price manipulation in California, legal uncertainty (Mirant, 2001) Higher cost being charged for credit backing risky trading operations ( UtiliCorp, 2002) Counterparty default ( Constellation 2008) 17

18 Impact of Downgrade on Liquidity up Liquidity Demand Liquidity Supply down 18

19 Ranking Liquid Assets On demand.. available now Unencumbered deposits, quality financial institution (A-) Unutilized credit facilities, deferred expiration date Convertible to cash.. need time Time deposits, other quasi-liquid investments Better WC management, flatten / reduce positions Contingent Cushion.. time & market confidence Commercial paper, receivables factoring Debt re-negotiation, re-scheduling Equity capital infusions 19

20 Lessons from Failure Enron (2001): A crisis of confidence Creative accounting, compounded by downgrade Ultimately a mismatch liabilities vs. liquid assets WorldCom (2002): Margin calls & fraud Margin calls on founder s pledged stock, co. loans Forensic audit, revealing insolvency Lehman Bros. (2008): Capital losses Exposure to the sub-prime mortgage market Fixed borrowings, crumbling assets 20

21 Liquidity at Risk and Stress Testing Randomized the liquidity risk drives and construct a distribution of liquidity need for a given time horizon => Liquidity at Risk Complemented by Stress Tests in the tail Liquidity needs under extreme market and credit scenarios (black swans): Commodity price collapse (or jump), coincided defaults of major counterparties, etc. Rating downgrade impact Liquidity shortfalls trigger by major operation risk Mean Difference 95% 21

22 Liquidity Planning Conclusions The Four Knows Know your counterparties Financial strength Quality of information getting on them Suite of agreements, thresholds and netting provisions Know your portfolio Product and commodity mix Counterparty positions Know your market Price trends and shocks Price correlations Know your numbers Liquidity thresholds Facility size relative to portfolio Cash cushion Downgrade impacts Liquidity shocks 22