Retail credit portfolio management IACPM Spring General Meeting - Munich May 2008 Gert Kruger, FirstRand Banking Group 2008 IACPM
Context Only 47% of CPM units manage retail credit exposures (McKinsey survey of CPM practices 2007) Retail CPM practices generally less well understood Role of retail credit risk v CPM functions not always clearly defined No universally agreed value proposition for retail credit CPM functions The aim of this presentation is to Explain through a case study of how the CPM function has been set up in FirstRand to include retail assets Discuss the tools and approaches used in the retail CPM activities Highlight successes achieved and lessons learned in the recent regional credit downturn Aim is to stimulate further debate on the role of CPM in retail credit asset classes 2 2008 IACPM
Background to FirstRand Banking Group (FRBG) One of the Big 4 South African clearing banks Operations in Southern Africa, UK, Ireland, Australia, India Retail activities, however predominantly in South Africa Total assets Eur 62bn (31 December 2007) Advances split (Retail 55%; Wholesale 45%) Total employees 40 000 3 2008 IACPM
CPM function organisational set up 4 2008 IACPM
Positioning of the CPM function with FRBG Originally established in 2003 in Wholesale credit function. Expanded in 2006 at Group level, with deployed team in Wholesale credit. CPM unit is located within the Balance Sheet Management unit (Group Treasury +) with a line reporting to the Group CFO Primarily advisory function with some decision making rights on hedging and distribution Close co-operation with other areas also on non-credit business unit objectives, e.g. funding and capital management FRBG Balance sheet management unit (50 FTE) Macro portfolio Macro portfolio management management (interest rates and forex) Credit portfolio management and Advisory (10 FTE) Capital management & strategic funding Equity & investment analysis 5 2008 IACPM
Credit assets in scope Retail assets Mortgages Vehicle and Asset Finance Credit cards Other unsecured lending Own balance sheet originated securitisation structures Wholesale assets Multinational corporates Domestic corporate entities (including SME s) 6 2008 IACPM
Credit Portfolio Management and Advisory (CPMA) functions overview New business CPMA In force business Influence origination strategy Macro economic outlook on credit risk Portfolio management Risk appetite, target portfolios Measurement & pricing advisory Credit capital allocation Measurement & Optimisation Expected losses, scenarios and stress testing, credit capital utilisation Analysis and reporting Internal and external reporting and communication Hedges cycle smooth Event risk protection Structured credit Advisory rights on new business, decision rights on portfolio management 7 2008 IACPM
Functional positioning vs credit risk functions Group Credit functions Reports to CEO Enterprise risk management: Group Credit control unit (CRC) Reports to CFO Balance sheet management: Credit Portfolio Management (CPMA) Segment credit functions Retail credit (Wesbank and FNB) Commercial credit (FNB) Wholesale credit (FNB&RMB) Group level functions: Group Credit risk control (GCRC). Independent oversight of group-wide credit process, policies and models. Credit Portfolio Management and Advisory unit (CPMA). Protect the balance sheet and income statement through hedging of existing portfolio to reduce risk, and active advisory function in respect of the origination process (credit outlook, pricing approach, capital allocation and provisioning). Segment credit functions: Specialist focus on credit segment value chain Operational management of credit segment processes and exposures Functional line into CPMA and GCRC 8 2008 IACPM
Tools and approaches used in retail CPM 9 2008 IACPM
Tools and approaches used in Retail CPM 1. Structured macro economic analysis for potential vulnerabilities 2. Advisory influence on business origination strategies and portfolio inflows risk appetite and targeted portfolios setting 3. Portfolio risk measurement tools 4. Portfolio management tools 5. Achievement of other bank strategic objectives 10 2008 IACPM
(1) Structured macro economic analysis: To articulate credit origination outlook and to identify hedging opportunities Tools Central credit outlook for origination Formulated by CPMA aligned to ALCO outlook Credit risk indices Segment specific lead indicators Others e.g. sector specific studies Example: Mortgage lead indicators 150 100 50 0 1996Q1 1997Q2 1998Q3 1999Q4 2001Q1 2002Q2 2003Q3 2004Q4 2006Q1 2007Q2 Nominal HPI Real HPI 300 200 100 0 Example: Retail non-mortgage credit risk index 150 100 50 1996Q3 1997Q2 1998Q1 1998Q4 1999Q3 2000Q2 2001Q1 2001Q4 2002Q3 2003Q2 2004Q1 2004Q4 2005Q3 2006Q2 2007Q1 2007Q4 Example: Retail affordability lead indicator Repayment to income rate in historical stress range (11.2%) 20 20 15 15 10 10 5 5 0 0 % 1996Q1 1997Q2 1998Q3 1999Q4 2001Q1 2002Q2 2003Q3 2004Q4 2006Q1 2007Q2 % retail non-mortgage average retail non-mortgage Average repayment to remuneration Repayment to income (rhs) 11 2008 IACPM
(2) Influence on origination activities: Combination of advisory role and shared decision making Tools Risk appetite and targeted portfolios articulation Joint decisioning on credit strategy to reach targeted portfolios Pricing advisory Capital allocation and funds transfer pricing Example of risk appetite drivers and targeted portfolio process Portfolio drivers Appetite levels Impact assessment Scores Ratings and cut-offs Approval Target rates market per score bucket Affordability Approval targets rates Collateral Affordability levels 1.00% 0.40% 0.20% Expected Volumes loss / market share Loss Volatility volatility vs appetite Capital levels IFRS ROE provisions / RAROC Capital allocation and funds transfer pricing aim to re-enforce desired behaviour Collateral Pricing curve levels Portfolio Calm Long run Turbulent Workout ROEimpact Levers that influence portfolio credit quality Loss tolerance rates for market scenarios Outcome of loss levels and business impact 12 2008 IACPM
(3) Portfolio risk measurement tools Feedback into origination as well as hedging activities. Tools: Use tools to provide additional insight over risk measures such as PD, LGD, EAD, ECAP Net flow analysis Macro economic simulations Natural hedge assessment Securitisation lifetime loss forecasting Scenarios and stress testing Example: Macro economic portfolio simulations Example: Net flow analysis loss forecasting 1.10% Portfolio loss Forecast (% of Performing) Example: Securitisation lifetime loss forecasting and stress testing Use best fitting vintage curve to predict longer term 1.00% 0.90% 0.81% Use Net Flow Analysis to predict the next 6 months 0.80% 0.70% 0.60% 0.50% 0.40% 0.30% 0.51% 0.60% 0.70% Cumulative Losses Actual cumulative losses to date 0.20% Mar-08 Apr-08 May-08 Jun-08 Jul-08 13 2008 IACPM
(4) Portfolio management tools Feedback into origination as well as hedging activities. Tools: Origination changes Inflow management Macro economic hedges Net of natural hedges Structured credit (e.g. securitisation) Other Example: Natural hedge offset assessment Example: Factor sensitivities: Portfolio interest rate sensitivity Sensitivity of another 50 bps in bps 0.45% 0.40% 0.20% 0.13% 0.12% 0.06% 0.04% 0.03% 50bps 100bps 150bps 200bps 250bps 300bps Card (Overdrafts Loans Asset finance Homeloans SME s Wealth Corporate Credit losses Endowment profits Net exposure 14 2008 IACPM
(5) Achievement of other strategic objectives Link to funding, capital, ALM and other objectives Tools: Structured credit As funding instrument As capital raising instrument Net exposure assessment Jointly with ALM exposures Market communication / investor relations 15 2008 IACPM
Successes achieved and lessons learned 16 2008 IACPM
SA Macro economic environment 2006-2008 Consumer debt repayment to income Deteriorating inflation, interest rates, consumer gearing Inflation 12 10 Interest rates 15 8 14.5 14 6 13.5 13 4 12.5 12 2 11.5 11 0 10.5 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 SA CPIX y/y 10 2005Q3 2005Q4 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 12 11 10 9 8 7 6 5 2005Q1 2005Q2 2005Q3 2005Q4 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 Debt servicing cost Prime Adverse environment for retail credit exposures 17 2008 IACPM
Hedging strategy Partnering with ALM (Macro Portfolio Management unit) Communicated to the investor market Assessment and hedging of net interest rate sensitivity Credit losses minus endowment benefit Out of the money option based interest rate structures Direct market transactions and structures embedded in insurance contracts Outcome as disclosed in results announcement Dec 07 5.6 1.5 1.3 4.3 0.9 1.1 Long run expected loss: 0.8 3.5 3.0 0.8 2.4 0.4 1.6 0.9 0.7 0.81 0.69 0.3 0.5 0.5 1.7 1.4 1.3 1.3 1.4 2.0 1.0 0.8 Insurance benefit Jun '99 Jun '00 Jun '01 Jun '02 Jun '03 Jun '04 Jun '05 Dec '05 Jun '06 Dec '06 Jun '07 Dec '07 NPLs (%) Impairment charge (%) Impairment charge (%) 18 2008 IACPM
Other successes achieved Improved transparency in the retail origination strategy setting process Investor mindset operating within investor mandate Partnering with credit risk and other functions Leverage on MIS infrastructure and achieving economies of scale Closer alignment with distribution function Improved understanding of origination impact on distribution 19 2008 IACPM
Lessons learned ALM and CPM needs to partner in macro hedging Otherwise run the risk of internal offsets ignored Macro economic hedges need to take account of central bank macro economic policy Growth v inflation targeting preferences Limitations of ECAP, EL etc as measures during a downturn Importance of loss momentum in retail portfolios during downturns Higher involvement of CPM required in origination strategies during benign parts of the cycle To align objectives in terms of cycle management 20 2008 IACPM
Concluding remarks 21 2008 IACPM
Concluding remarks Retail CPM can be a powerful value adding function within banks Complements retail credit risk functions Align with ALM and other functions Utilise CPM technology in both origination and distribution interaction Still comparatively little focus on retail CPM practices industry-wide Expect more attention going forward given the turn of the cycle Retail and Wholesale CPM can effectively co-exist in one function Economies of scale with respect to macro economic analysis Distribution techniques overlap (e.g. securitisation) Bank-wide perspective on portfolio vulnerabilities One port of call in investor and other stakeholders contact 22 2008 IACPM
Thank You Gert Kruger gert.kruger@firstrand.co.za 23 2008 IACPM