1. Asset & Liability Management
Introduction

2. What is ALM about ? Liquidity
Interest rate risk (in the main portfolio, not in trading books)
Balance sheet management

3. Balance Sheet Management
Capital
Funding
Bond issues
Deposit pricing
Portfolio Composition
Securitisation
Credit concentrations and their solution

4. ALM, business units, and relevant issues

5. Why do we need ALM ?
Maturity Transformation (banks borrow short and lend long)
Bank portfolios generate interest rate risk
Capital needs to be allocated and managed
Portfolio imbalances (eg. All retail deposits from one country)

6. Organising ALMAC The Asset and Liability Management Committee

7. The Balance Sheet, The Regulator and Bank Capital

8. Capital Adequacy Requirements
Capital Must Exceed 8% of Risk-Weighted Assets
Risk Weighted Assets calculated by applying factors (Risk Weights) to on & off-balance sheet items

9. Risk Weights

10. Examples of Capital Adequacy Calculation
Asset = $100M GECC Bond
Risk Weight = 100%
Capital Required = 8% x 100% x $100M = $8M
Example 2
Asset = $100M Deutsche Bank Bond
Risk Weight = 20%
Capital Required = 8% x 20% x $100M = $1.6M

11. Other Developments BIS 1996 BIS 2000+ Capital required for market risk
Three New Approaches to Credit Risk
Capital needed for liquidity risk, operational risk etc.

12. Three Approaches Approaches Internal Standardised Credit - Risk
Ratings -
based
Approach
Modelling
Approaches

13. Tiers of Capital Tier 1 Tier 2 Shareholders funds
Can be used to support trading and banking
Tier 2
Perpetual, medium, long-term subordinated debt, general provisions, fixed asset revaluation reserves

14. Tiers of Capital (Continued)
Short-term Subordinated Debt
Can be used to support trading activities
Aggregate Rule
Tier 2 + Tier 3 can only be used up to the level of Tier 1

15. Regulatory vs Economic
Economic capital is not the same as regulatory capital
Regulatory calculation basically flawed
Economic capital should be used for return on capital calculations

16. ALM Decisions and Capital Concerns
Portfolio Composition
Interest Rate (and other market risks)
Long-term funding

17. Liquidity Risk
Measurement and Management

18. Liquidity Risk Measurement
Construct a maturity ladder, and net funding requirement.
Assumptions on maturity are needed
Maturities can be contractual or expected or worst-case.

19. Assumptions for an Expected Mismatch
Likely maturity of retail deposits
Drawdowns of committed facilities
Seasonality
Discount to be applied to marketable securities

20. A Maturity Ladder Expected Maturity

21. Net Funding Requirement Expected Maturity

22. A Liquidity Ladder Contractual Maturity

23. Liquidity Management Tools of Liquidity Management
Standby Facilities
Marketable Securities
Can be used as collateral for loans through repos etc.
In the last resort ……
Central Bank facilities

24. Funding Requirement Contractual Maturity

25. Types of Interest Rate Risk
Repricing Risk
Exposure to changes in the absolute level of interest rates
Yield Curve Risk
Basis Risk
Optionality

26. Interest Rate Risk
Classification and Measurement

27. Parallel Shift

28. Steepening

29. Effects of Interest Rate Risk
Net Interest Income may fall
Net Asset Value (Portfolio) Value may fall

30. Measurement Techniques
Bucket and Gap analysis
Duration
Price Value of a Basis Point
Large Exposure Reporting

31. Measurement Techniques
More Advanced Techniques
VaR and Related Techniques
Monte Carlo Simulation
Historical Simulation
Dynamic Simulation including strategy and business changes

32. Interest Rate Derivatives

33. Interest Rate Derivatives
Interest rate swaps
FRAs
Eurodollar futures
Overnight Index Swaps
Caps & Floors
IROs

34. Interest Rate Swap
Bank
Swap
Provider
LIBOR
Fixed
Rate

35. Credit Exposure Profiles for Interest Rate and Currency Swaps
Time
Exposure
Currency
swap
Interest rate

36. Balance Sheet Management
Long-Term Funding

37. Long Term Funding - The Key Issues
Currency, Amount, Maturity
Investor concerns: Market Access
Hedging: Hidden costs of credit and capital
MIS

38. A Typical Long-Term Funding Process
Appoint
Lead Manager:
Advises on
Timing, Swaps,
Documentation
Set target, maturity, required currency
Assess
Proposals
Appoint Paying
Agent, Get tax
advice, listing
Sale to
Investors
Syndication

39. Standard Market Interest Rate Swap
Issuer
Swap
Provider
LIBOR
4.90%

40. Interest Rate Swap for a New Issue
5 Year Issue
4.75% Coupon
Issue Price
Fees 0.1%
LIBOR BP
Issuer
Swap
Provider
4.75%
Fees

41. Currency Swaps Start Interest Exchange Maturity Sterling Principal
Issuer
Swap
Provider
Sterling Principal
Euro Principal
Sterling Interest
Euro Interest
Start
Interest
Exchange
Maturity

42. Balance Sheet Management
Securitisation

43. Securitisation : Key Issues
Vehicle must be bankruptcy remote
Must be off balance sheet
Credit Enhancement

44. Securitisation Examples
Mortgage pass-throughs & CMOs
Credit Card Receivables
Collateralised Loan Obligations

45. Credit Enhancement Overcollateralisation Tranching Reserves
Credit Insurance

46. Mortgage Pass-through
Mortgages
Originator
SPV
Cash
Cash
Securities
Investor

47. Cashflow Details Credit Support Mortgagor SPV Servicer Note Holder
Principal Plus Interest
Mortgage payments less servicing fee
Note Holder
Servicer
Mortgage Payments
Collects payments

48. Tranching Principal Cashflows Time Fast Pay Medium Pay Slow Pay
Tranche A
Tranche B
Tranche C

49. Credit Derivatives
Basic Instruments and Issues

50. Types of Credit Derivative
Credit Default Swaps & Options
Total Rate of Return Swaps
Credit-Linked Notes
Various Spread Products

51. Credit Default Options
Fee (BP)
Bank A
Bank B
Zero
No credit event
Credit event
CEP

52. Total Return Swaps Bank B Bank A Bond C (Reference credit)
Total positive returns on Bond C
Bank B
Bank A
LIBOR + Spread +
Losses on Bond C
Bond C
(Reference
credit)

53. Credit-Linked Note Non-Principal Protected
Coupon
Issuer
(Bank B)
Principal
Investor
(Bank A)
No credit event
Credit event
Principal Less
CEP
Bond C
(Reference
credit)

54. Credit Derivatives and ALM
Can reduce credit risk concentrations
Can provide funding opportunities
Can be used in securitisation transactions
Under some circumstances, can reduce regulatory capital usage

55. A Typical CLO $100M in loans 50 senior secured bank loans
Average rating B1
Diversified by
industry & obligor
LIBOR + 275
5 Year Average Life
Class A
$85M
12 year maturity
LIBOR + 50
Aa3
Class B
$7M
12 year maturity
LIBOR + 120
Baa3
Equity
$8M
12 Year maturity
subordinated