Basilea III e Modelli di Business - moodysanalytics.com€¦ · Basilea III è più importante che...

Prof. Gianluca Oricchio, PhD, CPACBM University, Rome

Convegno ABI

Basilea III e Modelli di Business: C cosa abbiamo appreso dalla crisi?

Roma Giugno 2011

Convegno ABI – 20 Giugno 2011 Basilea 3 e BankingBusiness Models

Banking Business Models

CRO, CFO, CBU: Pricing discipline at origination

Business Case: Internal Capital Generation

Annexes:

I. Business Case

II. Credit Pricing & IT Logical Architecture

Agenda

Convegno ABI – 20 Giugno 2011 Basilea 3 e BankingBusiness Models2

BUSINESS MODELS AND CREDIT PORTFOLIO MGMT

Capital Turnover

Credit Risk

-

+1. Originate & Hold

2. Originate & Hedge

- +

3. Originate & Distribute

Drivers to be considered:

Basel 3 Impact

IAS Impact

Risk & Capital Management Instruments

Risk, Return and Growth by Segment


- A History Of Credit Cycle Turning Points -



Originate AndHold

Originate To

Distribute

Basel III Cost of Risk on Balance

Basel II Cost of Risk on Balance



1. La volatilità dei Tier Ratio è aumentata: x5

2. I “ tempi di reazione” si sono ridotti (Lezione #1)

3. Riorganizzare le relazioni fra CRO, CFO e CBU

Prociclicità dei requisiti e volatilità Fair Value IAS

tempo

Total Tier

Basilea I Costo storico

Basilea II Fair Value




Business Case: generazione interna di capitale

Annexes:

I. Business Case


Agenda


Il CRO stima e valuta il rischio (Markowitz X-axis)

Il CFO stima e valuta l’EVA (Markowitz Y-axis)


Lezione #2: CRO-CFO consistency (pricing discipline!)

(i)Spread risk adjusted(ii)EVA break even spread


Transfer Spread can be used as a benchmark of Credit Risk and Cost of Funding RM is responsible for the definition of the final price

Illustrative

Risk Free Commercial Price

Operating Cost

Forward Looking Credit

Spread*

Expected loss facing

Unexpected loss facing

Commercial Mark-up

Cost of funding

(non-binding opinion applied to Client)Transfer Spread

- Transfer Price components -

Various components contribute to define commercial price

(*) Credit risk spread defined by internal and external ratings models (Risk Calc Italy di Moody’s Kmw )



Lezione # 3: la generazione interna di capitale in Basilea III è più importante che in Basilea II(La prima leva è “ commerciale” !)

Il CRO deve saper “comunicare” con il CBU

Il CBU deve poter disporre di una “to do list” chiara



- Examples of Pricing reports -

(**) Risk Adjusted Spread is equivalent to Market spread Point in Time + Cost of Funding (March 2008) (***) Risk Adjusted Spread Mid Term Average as best proxy to calculate “through the cycle” spreads, Cost of Funding

included

“Risk Adjusted Spread” is non binding for final price but it is binding for RelationshipManagers performance

Loans are originated with a consistent risk/return profile

ILLUSTRATIVE

AWARENESS OF MISPRICING MANAGEMENT


~ 20% del totale sono rischi di tasso/funding

~ 70% del totale sono rischi di credito

..the missing ring…

Rischio di Tasso/funding Rischio di Credito

ALM CREDIT TREASURY





Business Case: generazione interna di capitale

Annexes:

I. Business Case


Agenda


Business Case: Internal Capital Generation

- Impacts on Credit Process -

As Is Pricing discipline

(*) Risk Adjusted Spread = insurance spread + cost of funding = Transfer spread

Credit Policies

Open Credit Request Documents Acceptance Load Credit Request

Origination Non Performing

Credit Request

Credit Mgmt

Opening Client/ Group dossier

Opening Facility/ Collateral dossier (focus on “fidi promiscui”)

Rating calculation Risk Adjusted spread(*)

settlement Synthesis judgment

Loan proposal (amount, risk adjusted spread, commercial spread)

Loan dossier sent to entitled credit structure

Loan Decision (amount, risk adjusted spread, commercial spread)

Loan activation Collateral perfection Contract Underwriting

Evaluation Proposal and Decision

Underwriting/ Loan Activation

Activ

ities

Risk adjusted spread settlement will impact on Origination phase of the Credit Process; real time calculation makes RMs aware of the credit risk impact

Impact on Relationship Manager MBO


Why is relevant pricing discipline at origination?

Commercial spreads on non-liquid portfolios are more volatile than market spreads

High commercial spreads are lower than market spreads for high-risky counterparties

- Fixed Income Market (bps) -

External Ratings

100

200

300

400

500

600

700

800

0AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B

CDS median + 2 σ

CDS median - 2 σ

CDS median

Internal Ratings

- Domestic Lending Market view (bps) -

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

3,5%

4,0%

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

3,5%

4,0%

1 2 3 4 5 6 7 8 9 100,0%0,0%

1 2 3 4 5 6 7 8 9 10

CDS median + 2 σ

CDS median - 2 σ

Insurance Price + Cost of Funding

Commercial spread


Internal Capital Generation: > 300 bps…

Short term loans (Capitalia Banking Group) M/L term loans (Capitalia Banking Group)

Spreads are applied basically irrespective of counterparty risk for new mid to long-term issues

The commercial spread/ insurance spread differential is negative above risk class 14

Positive correlation between risk (rating classes) and return (interest margin on average volume) for clients with new short term loan until class 19 Positive margins between commercial

spread and risk adjusted spread, on exception of high risk classes

EVA: +80 bps

RWA: - 35 %


The application of 1year EVA framework in Pricing models shows potential mispricing actions during credit cycle downturn

Short Term Facilities Long Term facilities

3m 6m 12m 24m 60m

12m EVA break even

EVA Break Even

expected maturity

~300% underpricing for

Long Term Facilities

Credit Treasury pricing methodology is market oriented (Nelson Siegel)

Credit pricing models are more accurate than 1 year EVA framework: the figure showsthat short term facilities are overpriced using 1yr EVA (when compared to market prices),while long term Facilities are underpriced

~40% overpricing for Short Term Facilities

ILLUSTRATIVE


Default Rates and Basel Capital Requirements: 1970 - 2007

0,00%

0,50%

1,00%

1,50%

2,00%

2,50%

3,00%

3,50%

4,00%

4,50%

mar-70ap

r-71

mag-72

giu-73

lug-74

ago-7

5se

t-76ott

-77

nov-7

8dic

-79

gen-8

1feb

-82

mar-83ap

r-84

mag-85

giu-86

lug-87

ago-8

8se

t-89ott

-90

nov-9

1dic

-92

gen-9

4feb

-95

mar-96ap

r-97

mag-98

giu-99

lug-00

ago-0

1se

t-02ott

-03

nov-0

4dic

-05

gen-0

7

0%

2%

4%

6%

8%

10%

12%

All corp - Default RateCapital Requ.

~1,5 yrs delay

~2 yrs delay

RWA are backward looking


“ Lessons Learnt” from previous credit crisis: “ Mind the gap” (~ 1.5/2.5 yrs time lag effect)

Market prices are “forward looking”

IRB RWA are “backward looking”

“Mind the gap”


~ 20% del totale sono rischi di tasso/funding

~ 70% del totale sono rischi di credito

..filling the gap…!

Rischio di Tasso/funding Rischio di Credito

ALM CREDIT TREASURY

…Minding the gap…


Lezione # 1: i tempi di reazione si sono ridotti (volatilità Tier Ratio)

Lezione # 2: CRO-CFO consistency (pricing discipline!)

Lezione # 3: CRO-CBU cooperation model (leva commerciale)

Lezione # 4: ridisegnare i processi organizzativi CRO-CFO-CBU (e costituzione di Credit Treasury)

Basilea III e Modelli di Business

MINIMIZZARE L’ENTROPIA ORGANIZZATIVA



Pricing discipline at origination

ACPM vs Credit Treasury business model

Annexes:

I. Business Case


Agenda


Capitalia turnaround on Pricing Discipline

Pricing discipline can improve the Loan Banking Book risk - return profile because:

it is strongly effective downside (risk);

it is relatively effective upside (growth)

P/BV 0.4x

ROE 0.5%

LP 210 bps

Tier 1 5.2%

CDS 120 bps

Rating BBB+

Start-up data

P/BV 1.7x

ROE 12.7%

LP 70 bps

Tier 1 6.8%

CDS 15 bps

Rating A+

2007


Market perception in 2002

In 2002, the market’s opinion of Capitalia was not positive

Merril Lynch “…We estimate that Capitalia will not beable to reach European standards on assetquality …”

2002 OPINION

UBS “…weak profitability and low credit quality…”

Deutsche Bank “…Capitalia has some problems in relationto asset quality, lack of capital andoperating inefficiencies …”

Moody’s “…the profitability of the group remainsmodest, with pre-provision profitabilitydeclining …”

Fitch Ratings “…the ratings reflect the continuing risk inthe credit portfolio, weak incomegeneration and a low capital base….”

Weak profitability

Lack of credit quality

Improving credit risk management techniques

Key Points


Capitalia Benefits estimation on New Customers

On short term loans the introduction of insurance price allowed the price mismatch balancing

IllustrativeOn mid-term loan the introduction of insurance price has allowed the credit rationing on riskier classes

Spreads are applied basically irrespective of counterparty risk for new mid to long-term issues

The commercial spread/ insurance spread differentialis negative above risk class 14

The dynamics of applied spreads only partly follows the rationale of LGD effect for acquiring collaterals (22% of products at maturity is covered by collaterals, even if focused on higher risk counterparties)

Positive correlation between risk (rating classes) and return (interest margin on average volume) for clients with new short term loan until class 19

Positive margins between commercial spread and risk adjusted spread, on exception of high risk classes

Spread applied to new clients is influenced by market pressure (competitors) especially for low and mid-low risk profile


Action Plan for restructuring

0,0

20,0

40,0

60,0

80,0

100,0

120,0

140,0

ott-0

2

dic-02

feb-03

apr-0

3

giu-0

3

ago-03

ott-0

3

dic-03

feb-04

apr-0

4

giu-0

4

ago-04

ott-0

4

dic-04

feb-05

apr-0

5

giu-0

5

ago-05

ott-0

5

dic-05

feb-06

apr-0

6

giu-0

6

ago-06

ott-0

6

dic-06

feb-07

Equity €

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

8,00

Capitalia Equityfrom 1€ to 7€

+ 600%

Capitalia 5yrs CDS

from 120 to 10 bps

CDS - bps

Stock price up from 1 € to 7 €

Credit Default Swap on senior debt down from 120 bps to 11 bps

Loan provisions down from over 210 bps to 54 bps

Asset quality control generates higher profitability: ROE up from 0.5% to 15.5%

From 2002 to beginning 2007

lead by CFOCREDIT RISKMANAGEMENT Pricing Discipline


Market perception in 2006: Capitalia’s results of restructuring

The market’s perception of Capitalia changed:

Credit Suisse FB

2006 OPINIONS

UBS

Deutsche Bank

Fitch Ratings

“…we recognize that the bank is clearly in a better position as a credible restructuringstory… ”

“…we believe Capitalia remains the most attractive restructuring story among Italianbanks…”

“Capitalia is the Italian restructuring story, in our opinion”

“Capitalia’s asset quality trend is better than the average for the Italian banks and itwill continue to improve faster than the other Italian banks, mainly due to new riskmanagement procedures”

“… Risk management across the group has been strengthened since 2002. Better credit risk management has led to better quality of performing loans …”

Goldman Sachs



Pricing discipline at origination

ACPM vs Credit Treasury business model

Annexes:

I. Business Case


Agenda


Pricing of liquid and non liquid portfolios

Key features

InsuranceModel

(liquid clients)

Liquid counterparties with quoted CDS (ex.: Large Corporate)

The spread curve can be interpolated from available market data

ClientIs there a liquid

CDS quote?Yes

No

Is rated byOfficial

Rating Agencies?

Yes CDS average (eg. Nelson Siegel)

Is rated by IRBinternal model

No

Yes

No

-PR

ICIN

G E

NG

INE

-

- MARKET PRICE -

Rating System TTC

Rating System PIT

Forward looking adjustement

Forward looking adjustement

-HYB

RID

PR

OD

UC

TS E

NG

INE

-

Internal Pricing Unit


Spread Curves – Process

Spread Curves Adjustments:

floor to 1-yr spreads so that spread1yr ≥ EL + kUL*

non-decreasing curve with respect rating scale and term structure

floor to overnight spread equal to 50% of 1-yr spread

spread for maturities below 1 year computed by linearly interpolating overnight and 1-yr spread.

Definition of the final spread curves is performed through the following adjustments:

AAAAA+AAAA-A+A

A-

BBB+BBB

BBB-

0 bps

10 bps

20 bps

30 bps

40 bps

50 bps

60 bps

70 bps

80 bps

90 bps

o/n 6m 1 y

r2 y

r3 y

r4 y

r5 y

r6 y

r7 y

r8 y

r9 y

r10

yr

Investment-Grade Curves

BB+

BBBB-B+B

B-

0 bps

100 bps

200 bps

300 bps

400 bps

500 bps

600 bps

700 bps

800 bps

900 bps

o/n 6m 1 y

r2 y

r3 y

r4 y

r5 y

r6 y

r7 y

r8 y

r9 y

r10

yr

Sub Investment-Grade Curves


CDS curve decomposition in Basel parameters

Liquid portfolio are priced in the market by mean of CDS curves

Internal perception of risk is summarized by PD and LGD

These points of view can be reconciled using a forward looking approach (anchor point and migration matrices).

Market(CDS 5yrs)

Internal parameters(PD, LGD)

CDS5yrs

EL

k * UL

= PD * LGD * EaD

Forward looking Anchor pointand

Forward looking Migration Matricesimplicit in CDS market curves


The Risk Adjusted Spread calculation: impact on RM operating processes

Following a loan request by a client (1), the RM opens the related request in the legacies front end (2)

The data retrieved from the legacies (3) are needed by the RM in order to start the loan evaluation phase and to operate the pricing tool (4-5)

The tool interrogates the dedicated CFO pricing engine (6) (with relevant financial and market data) and returns the Risk Adjusted Spread to the RM (7)

Functional support on the pricing methodology will be provided by GCT (8); technical support on the Pricing Tool will be provided by CA (9)

Based on the Risk Adjusted Spread (non-binding), the RM determines the proposed spread to the client (10) and finalizes insertion of the proposal in the legacy procedures

Pricing Tool archive spread and input data only if data will be saved by RMs

Feedbacks about IT and process structure are received in GCT by RMs

Each interaction within RM and GCT/ CA are memorizing in a log called “Light Monitoring”

- IT Logical Architecture - Phase I(*) -

CFOData Base

RM

Pricing Tool

Market Data

Pratica ElettronicaPricing Engine

LegaciesFinancing Credit cards

Pool Basel II

Facilities Comm. Ptf

Check.Acc. Cons. credit

Anagrafe …

Direct RM actionAutomatic system action

Client1 7

2 4

3

5

6

10

- Ex-ante process -

(*) The target architecture has been defined and will be implemented in Phase II

6

6

HoldingGCT CA

8 9


The Risk Adjusted Spread calculation: impact on RM operating processes

- IT Logical Architecture - Phase I(*) -

CFOData Base

RM

Market Data

Pratica ElettronicaPricing Engine

LegaciesFinancing Credit cards

Pool Basel II

Facilities Comm. Ptf

Check.Acc. Cons. credit

Anagrafe …

Direct RM actionAutomatic system action

Client

2

3

HoldingGCT CA

5 6

1

4

Once the request is inserted, the legacies procedures send all loan data to the CFO Database (1), which integrates them with the relevant consolidated market data (2)

The CFO Database using the pricing engine, compute ex-post the Risk Adjusted Spread (3) and compares it to the Transfer Spread manually inserted by the RM

In case of a mismatch, a notification e-mail is sent to the UBI (4): support is provided by GCT and CA (5-6)

In case of a mismatch, after verification with GCT and CA, RM (7) receive a feedback by UBI (7)

Each interaction within RM vs GCT and UBI are memorizing in a log called “Light Monitoring”

Risk adjusted spread is valid 30 days(between the proposal data and decision one)

- Ex-post process -

(*) The target architecture has been defined and will be implemented in Phase II

Pricing Tool

UBI

7

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