THE NEW ERA OF GLOBAL BANK RELATIONSHIP MANAGEMENT James Gilligan, CTP, FP&A Great Plains Energy, Inc. (Kansas City) Stephan Ireland -- Redbridge Debt & Treasury Advisory (Houston)
Every component of the banking relationship can strengthen it or weaken it Banking relationships are complex and subtle HISTORICAL and LONG STANDING relationship HUMAN based relationship Evolved with MUTUAL TRUST and CONFIDENCE Sometimes (often?) POLITICAL ADMINISTRATIVE A CHOSEN or ENDURED relationship ALL of it? But it is ALWAYS a relationship based on performance, risk and profitability KPIs 2
AGENDA 1 2 3 4 5 Regulatory background Bank reactions RAROC & economic capital Taking advantage of the new rules Questions 3
Basel III changed banks forever Capital requirements for banks were substantially increased Common Equity Tier 1 ( CET1 ) Tier 1 Capital Total Capital Common Equity Tier 1 Basel II Minimum Basel III Minimum (Effective Jan 2015) Capital Conservation Buffer (Effective Jan 2019) Total Minimum Ratios Maximum G-SIB Buffer (if applies) Basel III establishes a minimum Common Equity Tier 1 ( CET1 ) ratio Rules require more stringent adjustments to the calculation of CET1 Potential Minimum Ratios for Large Banks 2.0% 4.5% + 2.5% = 7.0% + 2.5% = 9.5% 4.0% 6.0% + 2.5% = 8.5% + 2.5% = 11.0% 6.0% 8.0% + 2.5% = 10.5% + 2.5% = 13.0% Non-Common Regulatory Capital Capital Conservation Buffer Non-cumulative perpetual preferred stock classified as Tier 1 capital Subordinated debt classified as Tier II capital Minority interests receive significantly reduced capital treatment Banks will be required to hold 2.5% of risk-weighted assets (RWA) in Common Equity Tier 1, above the minimum ratios, to satisfy this requirement and avoid restrictions on discretionary capital distributions
G-SIB surcharges Surcharge Bucket G-SIBs (effective Jan 2017) G-SIBs (effective Jan 2018) G-SIBs have even higher capital requirements 3.5% (Empty) (Empty) Systemically important banks are viewed as being 2.5% HSBC JP Morgan Chase Citigroup JP Morgan Chase riskier Global Systemically Important Banks (G-SIBs) are allocated to surcharge buckets corresponding to the higher loss absorbency requirements they would be required to hold Systemic importance is determined by computing a score based on the equal weighting of 5 factors: 2.0% 1.5% Barclays BNP Paribas Citigroup Deutsche Bank Bank of America Credit Suisse Goldman Sachs Mitsubishi UFJ FG Morgan Stanley Bank of America BNP Paribas Deutsche Bank HSBC Barclays Credit Suisse Goldman Sachs Industrial and Commercial Bank of China Limited Mitsubishi UFJ FG Wells Fargo Cross-jurisdictional activity (Banks with significant global operations) Size (Banks with large balance sheet assets and/or exposure) Interconnectedness (Banks with significant exposure to wholesale funding and counterparty exposure to other financial institutions) Substitutability (Banks with large custody, clearing and/or underwriting operations) Complexity (Banks with significant capital markets exposures and illiquid investments) 1.0% Agricultural Bank of China Bank of China Bank of New York Mellon China Construction Bank Groupe BPCE Groupe Credit Agricole Industrial and Commercial Bank of China Limited ING Bank Mizuho FG Nordea Royal Bank of Scotland Santander Societe Generale Standard Chartered State Street Sumitomo Mitsui FG UBS Unicredit Group Wells Fargo Agricultural Bank of China Bank of China Bank of New York Mellon China Construction Bank Groupe BPCE Groupe Credit Agricole ING Bank Mizuho FG Morgan Stanley Nordea Royal Bank of Scotland Santander Societe Generale Standard Chartered State Street Sumitomo Mitsui FG UBS Unicredit Group U.S. Banks highlighted in red
Basel III also seeks to limit leverage Basel III pressures RWAs and lending capacities Basel III establishes a minimum 3% Leverage Ratio: 3% Minimum*: Tier 1 Capital / Total Exposure (Effective January 2018) Exposure calculation utilizes Credit Conversion Factors (CCF) to convert undrawn commitments to a measure of exposure United States has more stringent Leverage Ratio Basel III minimum still applies as supplementary 4% U.S. Minimum: Tier 1 Capital / Avg on-balance sheet assets (Currently Effective) * U.S. G-SIBS subject to a 5% minimum CCF 100% 50% 20% Commitment Type Standby Letters of Credit serving as financial guarantees for loans and securities Sale and repurchase agreements and asset sales with recourse Lending of banks securities or the posting of securities as collateral by banks Forward asset purchases, forward deposits and partly-paid shares and securities Commitments with an original maturity > one year Certain transaction-related contingent items (e.g.: performance bonds, bid bonds, warranties) Note issuance facilities (NIFs) and revolving underwriting facilities (RUFs) Commitments with an original maturity up to one year Short-term self liquidating trade letters of credit arising from the movement of goods U.S. rules also have Liquidity Coverage Ratio (LCR) test High Quality Liquid Assets ( HQLA ) LCR = Total Net Cash Outflows Over the Stress Horizon > 100% (Currently Effective) Applies in full to depository institutions and holding companies with > $250 billion in assets or $10 billion in international exposure Net Cash Outflows defined as the highest daily cumulative net outflow occurring over a 30 day period 10% Commitments that are unconditionally cancellable 6
Basel III effect is passed on by banks to their clients Banks may no longer find your business profitable The Shrinking Bank Portfolio Teepee Possible investment banking portfolios Risk-Based Capital Ratio (%) = Regulatory Capital Risk-Weighted Assets Basel 3: LCR / NSFR Liquidity 7
AGENDA 1 2 3 4 5 Regulatory background Bank reactions RAROC & economic capital Taking advantage of the new rules Questions 8
Banking industry is adapting its business model to the new environment Consequences for corporates can be dramatic BANK REACTIONS CONSEQUENCES FOR CORPORATES Pricing Optimization Re-pricing credit facilities Increasing pricing on side Businesses More Stringent documentation Increase in bank fees Effective Risk Management Effective Customer Management Strategic Cost Reduction Reducing credit exposure & concentration limits Stricter credit approval processes Less flexibility Redefining Core clients list Devoting more or fewer resources to clients at specific levels of size or profitability Rationalization of branch structures Product rationalization Reducing resources (Improving C/I ratios) Targeting the AAAs? Funding Scarcity? Unsustainable funding policy Core Clients Service Quality & Coverage Rethink your bank relationship?
Many factors can explain why your business might not be attractive to a particular bank at a specific time Commercial Banking Investment Banking What makes your business attractive OR NOT to banks? Global Transaction Services Short term lending Trade Finance Cash Management Bank Core capabilities Medium Long term Financing Credit or Liquidity Facilities Leasing & Asset Based Credit Structured & receivable Finance Global Profitability Capital constraints Asset Management Custody (administrative) Short & Long term Investments Client s Attraction Capital Markets & Advisory Debt Capital Market Equities Capital Market M&A / Advisory Risk Profile Liquidity constraints Trading activities Rates / FX Equity Commodities Business Sector 10
Historical averages collected over the last 15 years Study based on 15 companies in the Global Fortune 1000 150 # of Banks per company 400 Bank fees (in $m) 100 104 300 320 50 0 44 13 Average 200 100-78 6 Average 100% 80% Efficiency Ratio (%) 86% 40% RAROC (%) 60% 40% 20% 0% 57% 40% Average 30% 20% 10% 0% Average 30% 14% 5% 11
How many banks do you need? Bank Concentration 80% 70% 60% 50% 40% 30% 20% 10% 0% Top 5 Banks vs. Total Revenues A B C D E F G H I J K L M N O Top 5 banks represent 59% of total business 80% 70% 60% 50% 40% 30% 20% 10% 0% Top 5 Banks vs. Total Economic Capital C B A F J D I N M H K L E G O Top 5 banks represent 50% of total EC 12
AGENDA 1 2 3 4 5 Regulatory background Bank reactions RAROC & economic capital Taking advantage of the new rules Questions 13
RAROC is a tool used by banks to create and protect value based upon their IRR requirements Risk-adjusted performance measurements encompass multiple sets of concepts Revenues (Credit margin, arrangement fees, side business ) Cost to Income Ratio Refinancing costs Depend on maturity Cost of Risk EAD x LGD x PD Revenues on Economic Capital LCR & NSFR Costs Ex-ante loan loss impairments RAROC = Revenues Operating Costs Economic Capital Liquidity Costs - Expected Loss Unexpected Loss, capital required to absorb losses up to a chosen probability of failure (usually 95% to 99%) EC = Basel III Advanced Approaches Risk Weight (K%) x EAD Function of EAD, PD, LGD & M We can add Operational & Market risk too (not chosen in our methodology) 14
Four major risk parameters are key in assessing Economic Capital and the bank s profitability RAROC: Behind the words are risk parameters Bank Exposures Counterparty Risk Exposure On/Off Balance Sheet (CCF) EAD Exposure at Default: What is the Bank s Actual Exposure a the time of default? Loss LGD Loss Given Default: How much will the Bank actually lose if you default? (Will the bank recover some of it?) PD Probability of default over next year Less: Collateral Maturity M Maturity: What is the duration of the Bank s commitments? Internal Rating 15
Data collected over the last 15 years Have You Heard About The Business Case? Average RAROC per product category Revenue Distribution 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Infinite Asset Advisory and Management Capital Market 41% Trading activities 36% Short Term Financing 20% Global Transaction Banking 6% Long term Financing Credit Side business 54% 46% Revenue Distribution Revenues distribution by BU 13% 26% Recurrent revenues Nonrecurrent revenues Commercial banking 87% 74% Investment banking 16
Analyze the impact of banking services on profitability Understand What Matters 14,0% 13.2% 13.7% Infinite 12,0% 11.2% 3066% 10,0% 8.7% 24.2% 7.7% 8,0% 6.1% 17.5% 32.4% 13,7% 6,0% 4,0% 6,1% 2,0% 0,0% Long term Financing Short Term Financing Trading activities Global Transaction Banking Advisory and Capital Asset Management Market Total 17
RAROC can help corporates more accurately price financial operations and adequately measure side business amounts RAROC RAROC RAROC RAROC And the sensitivity to all risk parameters 30% 35% 25% 20% 15% 10% 5% 7,41% 25,79% 19,63% 14,50% 10,46% 30% 25% 20% 15% 10% 5% 28,58% 19,60% 14,50% 11,29% 9,12% 0% BBB- BBB BBB+ A- A 0% 3 4 5 6 7 Rating Initial Maturity (years) 15% 15% 15% 15% 14% 14% 14% 14% 14% 13% 15,02% 14,76% 14,50% 14,25% 13,99% 100 110 120 130 140 Spread (bp) 15,5% 15,0% 14,5% 14,0% 13,5% 13,0% 12,5% 15,02% 14,50% 13,99% 13,47% #N/A 10 bp 20 bp 30 bp 40 bp Cost of Liquidity 18
Banks use Economic Capital & RAROC in different ways to create value for their shareholders RAROC & Economic Capital are strategic tools for banks Defining Risk Budget Depending on existing Capital & RWA, banks can calculate their maximum risk budget (Economic Capital) Allocating Risk Budget Allocation of EC per Business Unit, Desks, Products, Transactions Allocating per Counterparty (PD) Decision Making Used in approval processes (yearly analysis / transaction request) Subject to business judgment Performance Use selectively in pricing Link To EVA: If RAROC > Cost of Capital 19
AGENDA 1 2 3 4 5 Regulatory background Bank reactions RAROC & economic capital Taking advantage of the new rules Questions 20
Transparency is the foundation of a fair and long standing relationship If your bank tells you We are not meeting our rate of return, We need more business!» Ask what is your bank s hurdle rate (RAROC / RoRWA)? Does your bank have a profitability issue, fee issue, or both? Ask for bank fee reporting Always compare with the market and your peers Check how compares to other banks BUT: How and what to accurately compare? Be aware that each business / transaction has its own EBIT structure (Efficiency ratio) ASK your bank for average cost/income ratios Check annual reports (cost to income ratios) Is your bank using an internal rating process? What is your rating? Check what financial ratios your bank uses to assess your company What qualitative information does your bank assess? (Management, Industry, etc.) Sell your credit: organize annual bank meetings and sell your risk profile! Ask your bank to share their Internal rating in return Optimize bank capital by using less greedy economic capital instruments (securitization, factoring, receivables), by implementing a commercial paper program or issuing Private Placements. Cash or receivable collateral reduce significantly RWAs. Make sure you benefit from the reduction in your pricing / margin! Be careful when assessing the amount of liquidity lines. They tend to be the highest cost of capital to the bank. Do you have a liquidity policy? How often do you review it? Typically the longer the maturity, the better for your company (not for your banks)! Longer = expensive! Diversify your liquidity profile by issuing several bilateral credit lines with different maturities instead of a global RCF. You might even have better rates! If you don t ask, you don t get! 21
Rank your banks to decide how to distribute business Measure & quantify revenues, Economic Capital & RAROC Revenues 2013 Revenues 2012 EC 2013 EC 2012 (in M EUR) (in M EUR) (in M EUR) (in M EUR) 2013 RAROC 2012 RAROC BNP Paribas 32,8 26,1 24,8 23,1 39% 33% HSBC 20,1 15,0 12,4 12,6 40% 9% Société Générale 14,3 9,1 16,0 19,5 26% 13% Société Générale 14,2 9,1 16,0 19,5 26% 13% Crédit du nord 0,1 0,0 0,0 0,0 25% - BPCE 12,0 21,3 7,1 10,0 25% 38% Bred 4,2 11,4 0,2 0,5-207% 229% Natixis 7,8 9,9 6,9 9,4 31% 28% Intesa Sanpaolo 11,5 9,7 15,4 19,4 20% 14% Crédit Agricole 10,1 5,7 16,4 14,6 21% 13% RBS 9,7 4,6 8,9 11,8 24% 10% CITI Bank 9,6 2,0 4,2 4,3 62% 12% Morgan Stanley 6,3 9,7 2,5 3,6 63% 58% Barclays 6,0 4,6 9,6 14,0 15% 8% Goldman Sachs 5,8 2,7 3,6 4,4 39% 14% Crédit Suisse 4,9 2,3 3,5 4,1 37% 14% Deutsche Bank 4,7 6,2 4,8 2,8 23% 50% Lloyds 4,7 1,8 4,7 5,9 30% 9% Bank of America 4,0 1,7 7,0 6,7 16% 8% Nomura 3,4 1,5 2,2 2,6 40% 13% Santander 3,1 1,7 6,7 5,7 15% 10% CM-CIC 2,7 2,9 5,1 5,5 21% 20% ING 2,6 1,9 6,7 6,1 14% 10% Unicredit 2,3 2,0 11,1 10,5 6% 6% La Banque Postale 2,1 3,8 2,0 2,6 47% 76% Commerzbank 1,8 1,2 5,4 4,9 11% 9% BoTM 1,4 1,3 7,7 7,6 7% 6% Royal Bank of Canada 1,4 0,2 4,8 2,6 8% 3% Mizuho 1,3 0,2 4,5 4,1 9% 2% SMBC 0,7 0,3 2,3 2,7 10% 3% JP Morgan 0,6 1,4 0,9 1,0 18% 41% Wells Fargo 0,3 0,2 0,0 0,0 Infini Infini ANZ 0,1 0,3 0,1 0,3 15% 17% Nordea 0,1 0,3 0,0 0,0 323% 142% Total 180,5 141,8 200,5 212,6 24,45% 16,70% 22
Identify which banking relationships are profitable Bank Fees are not enough Hurdle rate Opportunistic or Banks in danger You are in danger! 23
AGENDA 1 2 3 4 5 Regulatory background Bank reactions RAROC & economic capital Taking advantage of the new rules Questions 24
THE NEW ERA OF GLOBAL BANK RELATIONSHIP MANAGEMENT Stephan Ireland Managing Director Redbridge Debt & Treasury Advisory Houston, TX 832-321-2754 sireland@redbridgedta.com James Gilligan, CTP, FP&A Assistant Treasurer Great Plains Energy, Inc. Kansas City, MO 816-556-2084 jim.gilligan@kcpl.com