Credit Portfolio Business Model & Iacpm Introduction

-IACPM Introduction
-CPM Business Models

2008

We cannot direct the wind but can adjust the sail. Restricted

We don’t know when it will rain, but we know it will.
‘ ’

AGENDA OF TODAY

•Introduce IACPM
-- International Association of Credit Portfolio Managers

•Why do banks need Credit Portfolio Management

•Sound practices of CPM business models

Copyright © 2007 ERIC KUO — Confidential
2

The International Association of Credit Portfolio Manager established in Restricted

2001 to further the practice of credit exposure management .
IACPM 立 2001年, ’ ’.

Who We Are and What We Are About

•Established in 2001 .

•Promote the practice of credit exposure management by providing an
forum to exchange ideas on topics of common interest.

•There are 87 financial institutions worldwide that are members of the
IACPM…

•..and from 14 countries and include many of the world’s largest commercial
wholesale banks, investment banks and insurance companies, as well as
a number of asset managers.

•Represents its members before legislative and administrative bodies.

•Conducts research on the credit portfolio management field.

3

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Many banks have participated in the portfolio management.
DZ Bank National City Bank
Aareal Bank
Euler Hermes Group
ABN AMRO Bank Natixis
Export Development Canada
Allianz AG Nationwide Insurance
Fifth Third Bank
Atradius NIBC Bank
FirstRand Bank
Australia and New Zealand Banking Group PB Capital
Fortis
Bank of America PNC
行
Bank of Ireland Primus Asset Management
Goldman, Sachs
HSBC
Bank of Montreal RaboBank
HSH Nordbank
Bank of New York Mellon Royal Bank of Canada
Hypovereinsbank Royal Bank of Scotland
Bank of Tokyo-Mitsubishi UFJ
IKB Deutsche Industriebank
Barclays Capital Scotiabank
ING Capital
行 SEB
Bear Stearns
Intesa Sanpaolo
BNP Paribas Shinsei Bank
JPMorgan Chase
Bluecrest Capital Société Générale
KBC Bank Standard Bank of South Africa
BP
KeyBank
Calyon Standard Chartered
KfW
Capital One Sumitomo Mitsui Banking Corporation
KfW IPEX-Bank
CIBC World Markets SunTrust Banks
Landesbank Baden Wurttemberg
Citigroup Swiss Re
Lloyds TSB Bank
Citizens Financial Group TD Securities
Manulife Financial Corporation
Chinatrust Financial Holding TIAA-CREF
行
Commercial Industrial Finance Corp. UBS AG
Merrill Lynch
Commerzbank U.S. Bancorp
MetLife
Commonwealth Bank of Australia Wachovia Corporation
Mizuho Corporate Bank
Monte Dei Paschi Di Siena
Credit Suisse Wells Fargo Bank
行
DEPFA Bank plc WestLB
Morgan Stanley
Deutsche Bank Westpac Banking Corporation
Munich Reinsurance
National Australia Bank
Dexia SA WGZ Bank
National Bank Financial
Dresdner Kleinwort XL Capital
4


’更
‘ ‘ ’

AGENDA OF TODAY

•Introduce IACPM



5

Facing the same down-side risk but the up-side is totally different that Restricted

利力
makes the stock investment –a winner’s game. ’ ’ ’ ’
利, 臨
.’ ’ ’ ’.

Payoff comparison of stock and loan

Return
Stock With
possibility of 不
‘high’ return

With high
possibility of
‘constant’
return
Loan

0

But faces the
same down side
loss with low
possibility
- 100 %

6

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The outcome of credit portfolio is asymmetric – A small number of bad loan
wipe your capital out.
歷 .
’不 ’

The game of credit portfolio
Probability
of loss
•Asymetric risk return pay-off.

•Long tail and concentration –
‘Once in a blue moon’ is more
common than we think.
‘Once in a blue moon’
rare happens but once
it does , you are
‘Sayonara’ Remedy

•Diversification
Reserve Capital
•Active portfolio management

Potential “unexpected”
Zero Expected Potential “unexpected” losses against which it
losses level of loss losses for which capital would be too
should be held expensive to hold
capital

Loss
0% 100%
rate
7

The definition of Portfolio management : Support the shift from Restricted

‘Originate & Hold’ to ‘Originate & Distribute’ – a new credit business model.
理’.
CPM , ’
Illustrative

Active credit portfolio management approach
Traditional credit management

Credit •Loan
Management Origination
Origination Trading
Relationship
Relationship •CDS
Monitor
Active
Management
Primary
Management Workout •CDS
Primary Secon-
Credit
Index dary
Portfolio
Market
Market
Manage- •CDO Market
ment
•ABS
Credit
Credit
•Portfolio
Approval /
Approval /
Rating Trading
Rating

Source : ERisk,

8


’理
‘ ’ ’

AGENDA OF TODAY

•Introduce IACPM



9

Restricted

Mandates of ‘Credit Portfolio Management’ Function .
行不
CPM ,

Common Mandates of CPM CPM unit may under..

•Analytical Function (We are here): •Business unit side
Capital management
─
─ Risk measurement
Limit / Large exposure management
─

─Portfolio Analysis Support business growth
─

Focus on ‘relationship’ and ‘Cross-
─Economic capital ─

selling’
─Monitoring
•Risk side
A hedge budget is prerequisite
Risk control ─

Hedge credit risk purely in the ‘Risk’
─
─ Reduce ‘Concentration risk’
perspectives
Support business growth Solve ‘concentration’ , ‘tail’ risk
─

•Independent unit
─ Capital management
Private side :Maximize Return / Minimize
─
Credit treasury Risk – Barclays bank
Public side : Fund manager ‘s approach
─ Diversified portfolio through ─

– HVB Bank
‘invest in Credit’

10

LEMG Organisation at Deutsche Bank also belong to the BU side. Restricted

DB is the winner of ‘Credit portfolio House of the Year in 2005’.
行理’ 理’ 理’BU Side’
’ ’ , .
Asset is transferred
based on either
‘Market price’ or 行
行
‘Model’.
If the CDS for a name
in the market asks for
300 bps, but RM only
ask for 100 bps , then
RM needs to pay for
the shortfall

Credit risk Group
Market risk Group

Note: LEMG = Long Exposure Management Group.
11

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Implementation takes time and DB began from simple .
理拓

Start with a subset of the total portfolio
Start with assets most closely aligned to the mandate given to CPM; assets
where CPM can create the most value
Allow time to build the infrastructure, data bases, expertise required by the
mandate
Large Corporate
Long-Term
Book:
Asia/Pacific

Large Corporate
Long-Term Book: Large Corporate
Europe Short
-Term Book

Large Corporate German
German
Long-Term Book: Mid
-Cap Book:
Mid
-Cap Book
Short Term
Long-Term
North America

2006
2005
2003 2004

12

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DB quotes an internal transfer price or “shortfall” for new loans, based on
參
capital markets benchmarks. CPM , ,
不論 CDS 行’ ’ .

Same
Price
Price for Market price /
internal transfer value

Business decision Credit
and cost allocation approval

Credit
Loan
Capital
Manages credit risk
Risk
Screening
Client strategy Markets
Management
Committee
and loan origination
Shortfall payment
Loan
Global Markets Exposure Transaction
Loan assets
Management
Global Banking s with
Group
markets

Residual P&L

•Sponsoring business divisions pay shortfall and loan is transferred to LEMG
•Sponsoring business divisions pay shortfall and loan is transferred to LEMG
•Upfront Shortfall = Cost of Hedge -- Revenues Generated from the Loan
•Upfront Shortfall = Cost of Hedge Revenues Generated from the Loan
(based on current pricing and assumed utilization)
(based on current pricing and assumed utilization)

Source : Andrew Rothery , Head of LEMG, Asia Pacific . Copyright © 2007 ERIC KUO — Confidential
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Mandates of ‘Credit Portfolio Management’ Function


•Business unit side
•Analytical Function :
Capital management
─

─ Risk measurement Limit / Large exposure management
─

Support business growth
─
─Portfolio Analysis
─

─Monitoring selling’
•Risk side
Risk control
A hedge budget is pre-requisit
─
─

perspectives
Solve ‘concentration’ , ‘tail’ risk
─
•Independent unit
Credit treasury Private side :Maximize Return / Minimize
─

Risk – Barclays bank
─ Diversified portfolio through
‘invest in Credit’ ─

– HVB Bank

14

PMU Organisation at Citigroup is separated, the ‘Public’ side responsible forRestricted

the trading and cannot access to the internal information. The ‘Private’ side is
under ‘Risk’ group and hedge credit risk with a budget.

Chinese Wall

Hedging Desk

Trading Desk ORR不
漏 Public
Trader
利
易

15

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Mandates of ‘Credit Portfolio Management’ Function


•Business unit side
•Analytical Function :
Capital management
─

─ Risk measurement Limit / Large exposure management
─

─
─Portfolio Analysis
─

─Monitoring selling’
•Risk side
Risk control
A hedge budget is pre-requisit
─
─

perspectives
Solve ‘concentration’ , ‘tail’ risk
─
•Independent unit – Bank
Credit treasury Private side :Maximize Return / Minimize
─

Risk – Barclays bank
─ Diversified portfolio through
‘invest in Credit’ ─

– HVB Bank

16

Shinsei bank considers its IB strategy : a platform of providing lending, Restricted

securitization, credit trading, capital market, advisory and asset
management.

17

Restricted

Structured credit activities contribute 26% of total revenue.
金來
2005年 , 26% ’ ’’ ’.

18

CDS market in Japan grows at an exponential rate, even though the lendingRestricted

, 歷了7年易量
rate is at record low. CDS
金– 利率
’2,713’ ’1.5%’ .
2001 ~ 2007 CDS Market Size –Japan
2007 CDS Market Breakdown – Japan
Loan Rate – Japan v.s Taiwan
Transaction focuses on the single name CDS in 2007 and
Low lending rate is not an excuse for developing the
accounts for 71% of total transaction.
CDS market, on the contrary , it becomes a fuel
,motivation to hedge credit risk under the low interest In terms of tenor, 80% of volume concentrates on 1 to 5 Year
rate environment in Japan. CDS.
Lending rate(%)
CDS Volume (Unit : US Billion )
Unit : US Million
300 8
271,383 271,383
271

43,118
6.49 Above 5 Year
Taiwan Lending rate
76,669
Multi-Name CDS
6
Japan Lending rate
200 183

143
4
3.22
1~5 Year
218,968
194,713
100 Single name
2
1.46
1.48
31
25
18 14 9,296
1 Year CDS
0 0
Name Tenor
2001 2002 2003 2004 2005 2006 2007
Source: Bank of Japan. Figures show the notional amount of transaction on the Aug 2007.
Lending rate represents for the Lending revenue rate instead of credit spread.
Taiwan ‘s average loan rate is from 料,
行
2007年9 23.5 Billion
易量 Copyright © 2007 ERIC KUO — Confidential
19

The originator pays a subsidy if low return assets are written for relationship
Restricted

reasons. Moreover ,Barclays does not believe that good business has been
lost due to the subsidy system.

20

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Barclays manage portfolio as a tradable securitization and change its
weighting regularly.

21

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The common challenge is – There is not a credit market in Taiwan.
來 , ’First Mover’s Advantage’ .

..it all can be resolved if we want to.
Usually Banks face the challenge..
•Market won’t grow by its own
•Credit market is illiquid
J.P Morgan is the first mover in CDS, back to 1997 when no
─

─ CDS price is too high one knew what is CDS .
Chinatrust bank can wait for the market matured or become the
─
─ ‘Equity tranchee’ is hold by
market maker in Taiwan.
bank and cannot sell it out
Foreign banks, such as Citi, Standard Charter,ABN in Taiwan
─

have already began to manage their portfolio.
Mind-set
•Headline risk is managed
─ Buy protection means give
Credit risk is remote and RM can focus more on ‘cross sell’.
─
‘Revenue’ away
Estimate hedge benefit based on the ‘EL+CapCost’ – ‘Hedge
─

Cost’
─Performance is reviewed
One large corporate loan might wipe out our capital overnight.
─
largely based on ‘Revenue’
•Capital is not a ‘Free Lunch’
Low Incentive
Capital allocation will be implemented in 2008.
─

Credit line can be relieved if ‘equity’ is sold out-most practices;
─ No capital pressure ─

however, some practices begin to recognize the remote of ‘tail
─ Credit line relief risk’.

22

Restricted
The possible way is to focus on the ‘Well-known’ names who usually have larger
exposures and bring more ‘cross-selling’ revenue.

Facts
EAD
RAROC (%) •15% of our
100 % = Capital/EAD per Client
corporate clients
account for 37% of
exposure and
consume 43 % of
capital.
57 %
Un-public 62.8 % 18
104 Million
85 % 6.7% •These small portion
clients are ‘Public
listed’ and are ‘well
known’ by the
investors.
•Deliver higher
18
8.8 % 489 Million
RAROC to CBG and
27.6%
usually have thin
23.0%
‘credit spread’ and
‘larger exposure’
3.9 % 429 Million 41
TSE
7.0% 2.8%
5.3% •Usually recognized
15
10.2 % 301 Million
ROTC 2.0% as ‘Good’ asset and
7.9%
5.7%
3.0%
Public Offering
has less credit
29
4.0% 9.7% 129 Million
4.3%
3.2%
OTC
concern.
# of Client EAD AIRB Capital 19
Avg = 141 Million
Should be our first
target.

23

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CPM and the new model of commercial banking

Traditional model of commercial banking Credit Portfolio management change the game

Obligor Investors
Obligor
CDS
Deposit Loan Loan CLO
Loan
Bank
pool

Translate the ‘Risk’
A new model of
Banker as the intermediary –
–Globalization of financial
commercial
collecting savings and providing banking is markets
emerging that is
loans that were held to maturity
–Increased economic volatility
based on
– Loan consumed ‘Capital’ competition and
–Low price high competition
open markets
– Regulatory legislation
Into ‘Opportunity’
watch BIS ratio and NPL
–CDS market becomes more
– Bank focuses on bi-lateral
liquid.
relationships
–CLO market becomes more
acceptable
This model has been under
–Capital can be free up through
pressure for the past 40 years
‘Risk mitigation’

24

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更
Velocity , Cross-sell .

狀
Credit Portfolio
• 理
•
─ CLO /CDS (BU
─ ,
), Velocity .
─ CPM BU 利
理
• 度
─ 度
─ , Portfolio level limit
─ (Unexpected)
boundary

─
─ , 行
─ CLO來Relieve Credit
─
Line

•
─ CDS,

─ Sell protection, ─ CDS 來

25

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Structured credit may result in different rating structure, below is a
simple example to assess its benefits.
Illustrative
No Capital Relief
A

Rating NII
Coupon
Assume securitize 10,000

Credit asset 30% AAA 20 bps 6

Decision Scenario
60% BBB 100 bps 60
Original Asset Structure BB
If Asset has good quality,
hold ‘Equity’ with no capital
10% Equity 340 bps
Cap 34
BIS=8%
800
relief benefit but has higher
100
OS 10,000 return
3% Capital relief
B
Hold ‘AAA’ and utilize ‘Cap
NII 100(100bps)
Rating NII
Coupon
10,000
Relief’ to support other
30% AAA 20 bps 6 business

Hold ‘AAA’ and partial
65% BBB 100 bps 65
‘Equity’
BB

5 % Equity 580 bps 29
100

Source: Team analysis Copyright © 2007 ERIC KUO — Confidential
26

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Tranched protection typically has a bigger impact on Economic Capital
than it does on Expected Loss.
ILLUSTRATIVE

BBB
BBB
AA

Hedged
EL AAA Credit risk is remote
EL

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10

Retained
Ecap (Pre-deal) Ecap (post-deal) ~ Ecap (pre-deal)
Tail risk

. Pre Deal Post Deal
Economic Capital (AA solvency) 6.2% 2.3%
UL 3.2% 2.7%
Average Default Correlation 5.1% 4.1%
EL 3.6% 3.5%

Source : IACPM , Oliver Wyman penal discussion
27

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In order to allocate these capital savings to individual loans we can match
the loss ratio with the loss amount and feedback to notional credit line
relief.
ILLUSTRATIVE

Loss ratio
100%

50%

0 1 2 3 4 5 6 7 8 9 10 11 12
Loss($)
Retained Hedged / Sold to investor

Equity tranche

0 1 2 3 4 5 6 7 8 9 10 11 12
Loss($)

1 2 3 4 5
Loss ($) (Pre-deal) 6 7 8 9 10 11 12

1 2 3 4 5 6 6 6 6 6 6 6
Loss ($) (Post-deal)
100 100 100 100 100 100 86 75 67 60 54 50
Loss Ratio% (Post/Pre)

There are no In percentage terms,
savings at the savings are greatest
attachment point along with loss increases
28

Credit Portfolio Business Model & Iacpm Introduction

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