otbert de jong head pm ap / global head risk advisory may 14, 2004 overcoming challenges to active...
TRANSCRIPT
Otbert de Jong Head PM AP / Global Head Risk AdvisoryMay 14, 2004
Overcoming Challenges To Active Portfolio Management
PRIMA, Singapore
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Contents
1. PM, Basle II, RAROC and Economic Capital
2. Introduction of Portfolio Management in ABN AMRO Bank
3. Position of PM in the Organisation
4. Definition of the PM Mandate
5. Performance Measurement
6. Organisation & Key Management Tools
7. Overcoming Challenges in Managing the Portfolio
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Basle II, RAROC and Economic Capital
How does it all fit? Basle II will bind regulatory capital to credit quality
Regulatory/Economic capital will be measured on the basis of 3 main risk factors: market risk, credit risk and operational risk as the amount of capital that will be required to support these risks
RAROC: Risk Adjusted Return / Economic Capital
Economic Profit: expands RAROC by incorporating the cost of equity capital
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Basle II, RAROC and Economic Capital
Simply put, Economic Profit is:
Revenue
less: Cost (operating)
Provisions
Tax
Cost of Capital
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Introduction of Portfolio Management
Economic Economic SlowdownSlowdown
Bursting of Tel. &Bursting of Tel. &Tech BubblesTech Bubbles
PoliticalEventsOperationalOperational
fraudsfrauds
AccountingAccountingscandalsscandals
Environmental
Increase in loan losses and
provisions
BIS IIBIS II
Desire for Desire for pricing pricing
disciplinediscipline
Capital reductionCapital reductionin lendingin lending
Understand true Understand true liabilitiesliabilities
Better Credit Management
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Introduction of Portfolio Management
The Loan Portfolio takes Centre Stage:
– Need to better measure the quality and quantity of the portfolio
– Need to better balance and “manage” the portfolio
– Need to improve rating processes
– Need to manage capital invested in lending business =
leading to emphasis on economic capital vs regulatory capital
Portfolio Management introduced as part of the credit and capital management architecture
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Introduction of Portfolio Management
Major steps:
– Positioning of Portfolio Management in the organisation
– Definition of the mandate of PM
– Internal buy-in
– Data and systems
– Definition of portfolio parameters and performance measurement
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Positioning in the Organisation
Wholesale Clients
Pro
du
ct
Bu
sin
es
s U
nit
s
Financial Markets
Global Transaction Services
Private Equity
Equities
Client Business Units
TMT ACD ECP FI&PS
Corporate Finance
Risk / Compliance / Legal / Audit / Human Resources / TOPS
Change Management
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Challenges
In the introduction of PM one faces 2 types of Challenges
1. Self Made challenges as a consequence of
insufficient preparation or
definition of mandate => boundary battles
2. Institutional challenges: inertia and change management
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PM Mandate
Which portfolio?
Decision rights (and at which stage) ?
Client relationship implications of making PM a profit centre?
Format for compensation for loss making deals?
Allocation of capital for investment activities?
Product type (loan, CDs, bonds, …)?
Accounting implications?
Just a few of the questions to be answered:
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PM Mandate
PM mandate
Portfolio Originator
Hedging, selling andbuying exposure,actively managingagainst portfolio
parameters
Portfolio Management
Both Origination andPM
Owner of Portfolio
Owner of P&L
Monitor
Monitoring andreporting
Origination
Origination
Hedging and selling existing
exposure to improve
risk/improve diversification
Origination
Origination. PM has shadow P&L
Hedger Asset Manager
PM becomes a business on its
own merits
Portfolio Management
Portfolio Management
Roles / Function?
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PM Mandate“Origination Shop” “Shadow Portfolio” “Balanced Model” “Portfolio Originator” “Fund Manager”
Market Posture “Defend” “Hedge” “Attack”
Aim of PortfolioManagement function
Overview of portfolio toinform business decisions
Portfolio optimisation(sell / hedge) to improve
risk / return
Active management (buy /sell / hedge) as own value
proposition
Active management ofrisk and return as main
value proposition
Asset management asstand-alone business
Positioning of PortfolioManagement function
None / Passive Reactive Proactive Leading In control
Formal split betweenPortfolio Management andOrigination
None Distinct functionsInformal arm’s length
relationshipFormal arm’s length relationship
Change to credit “businessmodel”
None Enhance business modelReconstruct business
modelFundamentally reconceive business model,
“no turning back”
Who takes creditdecisions?
Origination OriginationOrigination, subject to
product designOrigination, subject to
product designPortfolio Management
Who owns the creditassets?
OriginationOrigination or
Portfolio ManagementPortfolio Management Portfolio Management Portfolio Management
Portfolio Managementinput to asset selection
N/AAccepts all assets at
transfer price, has no inputon inflows
Accepts most assets attransfer price, has limited
input on inflows
Accepts assets at transferprice; has discretionary
vetoN/A
Who owns the creditP&L?
OriginationOrigination; Portfolio
Management has “shadowP&L”
Both Origination andPortfolio Management
Portfolio Management Portfolio Management
Consistent with BIS II inlong term?
Yes Yes Yes Yes Yes
ExamplesTraditional universal
banksAbbey National,
SE BankenUBS, Standard Chartered
HypoVereinsbank(mortgage)
[Freddie Mac]
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PM Mandate ABN AMRO
Through:
– Increased efficiency and a streamlined Credit Process
– Attention to biggest value drivers: Provisions and Economic Capital Cost
– Stronger pricing discipline by instilling a better appreciation of Economic Capital
– More active management of the portfolio within enhanced Portfolio Parameters
– Increased decision rights
– Changes in the origination behaviour
PM is responsible for managing the loan portfolio with an objective to maximise Economic Profit within a client driven wholesale bank strategy.
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PM Mandate
PMG :
– Obtained full P&L responsibility for the Loan Portfolio
– Obtained enhanced participation on Engagement and Credit Committees
– Introduced Shortfall Compensation Payments
– Obtained discretionary investment rights
– Sole discretion over asset disposals or hedges
– Developed tools to actively manage the portfolio
PMG is responsible for managing the loan portfolio with an objective to maximise Economic Profit within a client driven wholesale bank strategy.
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Performance Contract
Old P&L:
+/+ Credit Revenue
-/- Operating Expenses (direct + indirect costs)
-/- Provisions Budget
-/- Tax
-/- Capital Charge (BIS 1)
Performance EP (stand-alone basis):
+/+ Credit revenue
-/- Direct costs
-/- Provisions based on Expected Loss
-/- Tax based on a global average
-/- Capital Charge based on Econ. Capital
Performance Contracts Based on Economic Profit (“EP”) and RAROC
Alignment with other parts of the business is important !
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Organisation Portfolio Management
Portfolio Strategy/Executi
on
Credit Portfolio Management
Portfolio Analytics
Asia Pacific
Europe
Benelux
America
South America
(500)
Amsterdam
(20)
Asia Pacific
Europe
America
US
(25)
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PMG Filter
Portfolio Parameters
Loan Pricing Tool
Shortfall Compensation Programme
Key Management Tools
New In
WCS Loan
Portfolio Old Out
Enlargement of PM’s Mandate required enhancements to Key Management Tools
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PM Filter
Is the facility EC greater than EUR[750k] and belong to a Corporate
Industry Sector EC Concentration > 9%and/or EC/Limits greater than [xx] bps
Does the facility or relationshipbreach Obligor EC Concentration
limit of EUR 7 million[or higher approved limit]
CPM & Client RM to review -Action Plan prepared if EC > EUR
10 million
Does Product Type relate toPMG Portfolio
Proceed to GRM / GRC
Does the facility generate anEP Loss > EUR 50,000
No
No
No
Yes
SCP ScheduleProduced
Yes
Yes
Yes
PMG Filter applies to all WCS credit applicationsfor new, renewal or extended credit facilities
PMG Strategy to deliverappropriate input for credit
application
Facilities supportedby PMG Portfolio Parameter
SCP ProgramParameter
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Loan Pricing Tool
Major Inputs:
Credit Rating => PD
T & C Risk
LGD
Legal Risk
Collateral
Tenor
Expected Utilisation
Industry
Revenue and Opex
Major Outputs:
Economic Profit
RAROC
Benchmark Pricing
ROS
Economic Capital
Regulatory Capital
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Shortfall Compensation
Credit Income vs Relationship income
CPM receives compensation for Economic Loss from other product area in case of major cross sell
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Managing the Portfolio
Sales/Origination
Risk
ManagementCPM
Investment Portfolio
Economic Performance:
Risk / Reward / Diversity
MeasuringMeasuring
PredictingPredicting
NegotiateNegotiate
BenchmarkBenchmark
Industry/ Industry/ GeographyGeography
Rating / TenorRating / Tenor
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Minimising Provisions
(Important Value Driver)
move away from higher risk categories
historical and forward looking analysis
diversity: geography / industry matrix
use of KMV
active portfolio management incl. timely exit
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Cost of Capital
(Next Important Value Driver)
Only Economic Profit positive or min. RAROC % transactions
Portfolio Optimisation
Exit low yielding relationships
Augment primary business with secondary market opportunities
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Portfolio Management Instruments
Primary Origination
Purchase/Sale in Secondary Loan Markets
Hedge (insurance or credit derivative)
Selling Credit Protection
Buying /selling in bond market
Exercising put options
Risk Distribution e.g. CLO /Securitisation
Portfolio Trades
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Monitoring
Real time review and update of obligor credit ratings
Forward looking ratings, detect credit migration, perform stress testing
Model calibrations
Sector and geographical reviews and concentration
Monitoring of RAROC and EC/limits and EL/limits (monthly)
Data accuracy and procedure improvements
Early involvement in potential transactions
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The universe of Portfolio Management
Credit MarketsCredit Markets
Other Other Product BU’sProduct BU’s
Risk ManagementRisk ManagementFinanceFinance
CreditCreditAdministrationAdministration
AuditAudit & &
ComplianceCompliance
Relationship Relationship BankingBanking
StrategyStrategy
Other Other GeographiesGeographies
BudgetBudget
ExecutionExecution
Management
PM
RegulatorRegulatorIndustryIndustry
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Sources of problems
No buy-in / commitment by all stakeholders (see universe of PM on previous slide)
Incoherent formulation of mandate of PM
Poor execution
Poor or lack of supporting systems
Poor data quality and/or maintenance
Most of all: Poor communication
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Technical challenges
Tools: start simple and build it up. Don’t run if you can not walk
Measuring: quality over quantity
P & L : solve boundary issues quickly
Centralise and have specialists and “champions”
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Change Management
Create buy – in / commitment
Communicate
Report
Success breeds ……………..
Strategy and Determination
Professionalism
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Results to date
Very encouraging:
Marked improvement of RAROC
Reduction of RWA by 30+% at equal revenues
Big change in origination behaviour
Catalyst for better credit assessment and better measurement
Further upside in portfolio optimisation and arbitrage
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Risk Advisory Service
Risk Management strategic and implementation advice for Financial Institutions:
BIS II, ORM, CRM, MRM, ERM,
Support on strategic issues such as capital budgeting, capital allocation, strategic choices, systems selection, organisational change, RM implementation programs, coaching and specialist services.