credit portfolio management unit introduction

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Credit Portfolio
Management Introduction
2008/08/04
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Agenda
1. Brief Introduction of Credit Portfolio Management
2. Reshape portfolio Through Portfolio Analysis
3. Ideas of portfolio improvement
20080804 Eric — Confidential
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A CPM in bank is usually either led by risk or within BU.
Chief Credit Officer CEO of Corporate Banking Group
Credit Institutional
Corporate
Capital Market
Retail Credit Integration Bank
Credit
Department
Line of
Credit Portfolio Credit Trading Securitization Business
Responsibilities • Execution is done by ‘Capital market’.
• Either through CDS or CLO
• Analytical
• Management Relationship
Sales force Sales force Manager
• Risk Solution
• Other Basel 2
Focus more on analytical related issues
Interact with
and management
LoB and
aspects and to build
Capital Market
mechanism within the
organization
20080804 Eric — Confidential
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CDS market in Japan grows at an exponential rate, even though the
lending rate is at record low.
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
6.49 43,118 Above 5 Year
Taiwan Lending rate
76,669
Multi-Name CDS
Japan Lending rate 6
200 183
143
4
3.22 1~5 Year
218,968
194,713
Single name
100
2
1.48 1.46
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 Central bank of Republic of China. 20080804 Eric — Confidential
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The credit derivatives market in Taiwan is growing but is far smaller compare
to Japan’s. Most of the hedge activities are private placement instead of done
via trading desk.
Over-banking result in a low margin
Credit derivatives Volume comparison loan market
Most of the hedging structure are rudimentary type.. Current average credit spread is around 120 bps in
the loan market.
..mainly due to ,the Clients want to have simple
structure. Large corporations usually utilize the syndication to
finance their needs, the average spread is less than
120 bps….
271,383 * Unit : US Million
..this adds the difficulties to reduce risk through
capital market.
3,286 ** 1.2%***
709 Hedge purpose 0.5 % ~1.2% Most likely
**** can be placed
through CDS
& CLO
Trading purpose
2,577
Market average Large
loan spread corporates loan
spread
Japan Taiwan
* Bank of Japan. Figures show the notional amount of transaction on the Aug 2007.
** End of April ,2008 ,Financial statistics abstract
*** Average lending spread after the CP rate(90 days) Central bank of China
20080804 Eric — Confidential
**** estimated by using syndication loan 5

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The implementation of the ‘limit boundary’ as a means to force LoB to
reduce risk. Also to prevent from the excuses of high hedge cost.
Solution of expansion & constraint
Industry Portfolio Limit Taiwan Overseas
boundary Solution Challenge
Market Size Opportunity
•Subprime adds more
•Credit link note
Y
Y
Hi-Tech
difficulty
•CLO
Room for
Y
N •Usually for the
Service expansion •Buy insurance
transaction based
Financial lending
Y
Y
•Loan sell •Most common
Y
Telecom
•Sub -participation
Manu-
Reduce exposure
facturing Y
Limit Capped
Current Exposure
Risk needs to be transferred instead of simply being controlled.
However, the reality is difficult to execute portfolio hedge.
20080804 Eric — Confidential
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Major hedge decision point for the LoB lies on if they can arbitrage even
they are forced to do so.
..financial group concerns about the P &
L as well.
Like most organizations in Taiwan
Usually the regulatory capital relief plays an important role hedge activities tend to be viewed as a
in making hedge decision .. waist of money.
saving
X Cost of Capital = Y
Y
Risk adjusted Risk adjusted
profit before profit after
EL Total Cost of Final
Capital Capital Capital
hedge hedge
saving saving hedge Saving
cost
Usage Usage
saving Or
before after
additional
hedge hedge
cost 20080804 Eric — Confidential
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Externally, the structure of the hedge activities depend on clients’ needs. I
don’t generally responsible for the structuring, only provide comments and
support.
Observations
Clients will compare with other investment products
Structured
Generally prefer a product that is simple and transparent
credit
In terms of credit linked product, clients only interested in
product
the big names or the names they are familiar with.
Clients general concern about the accounting treatment
and impact to their financial report.
Accounting
treatment Especially when product requires ‘ Mark to market’
Some clients discuss the possibility of using this
As collaterals investment as collaterals .
20080804 Eric — Confidential
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No capital-relief in our recent CLO experience.
Illustrative
Rating NII
Coupon
Original Asset Structure 10,000
30% AAA 20 bps 6
•Structure of the CLO requires
Cap BIS=8%
800
to meet the investors’ needs
60% BBB 100 bps 60
OS 10,000 •Relationship managers
BB
usually ask for the limit relief
NII 100(100bps)
10% Equity 340 bps 34
100
20080804 Eric — Confidential
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Although there are many types of role in the CPM , we are in the
advisory stage.
We are here
20080804 Eric — Confidential
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Agenda
1. Brief Introduction of my experience in Credit Portfolio
Management
2. Through Portfolio Analysis to reshape the portfolio
3. Ideas of improving portfolio
20080804 Eric — Confidential
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Utilizing the ECap to identify the concentration risk .
Illustrative
Industry Concentration
The chart exhibits the
industry concentration risk.
EC = RC
If the EC is equal to the EC > RC illustrates the For the industries that EC
demonstrates the risk
AIRB Cap which means the higher risk or > RC, Banks need to dig
is properly expressed
risk is properly identified by concentration risk in UL
into further to understand
under Basel 2
using the Basel 2 capital context.
formula. the
formula, as shown in the ‘B’
-Profitability
industry. A
-Industry outlook
Higher EC than RC, for EC > RC Zone
B
example the ‘A’ industry,
-Relationship
illustrates the the AIRB
-Business strategy
Require
capital is under-estimate the Economic
to
capital and also is an good Capital before taking action.
Opportunity
Reduce
illustration of ‘Concentration
to Increase
risk
For those industries that
Risk’. risk
exposure
EC<RC:
exposure
The causes of the
concentration effect may Banks can consider
result from :
expansion after consider
•Larger ‘exposure’
EC < RC stands for -Industry outlook
•Rating the UL is lower than
-Market size
Basel 2‘s .
•Recovery rate of collaterals
-Cross-sell opportunity
•Net interest income AIRB Capital
•Correlation
…of certain industries 20080804 Eric — Confidential
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Leverage the RAROC metric to gauge if the risk / return of current
portfolio is justified.
Illustrative
Return & Capital allocation Potential hedge names selection
Most of the lending business rarely can deliver Lending business will inevitable faces industry
risk adjusted profit, banks require to cross sell concentration, though, bank need to balance the
more fee-based income to compensate the risk risk and return.
taking activities.
RAROC
A Total
X-Sell RAROC
Cost of Capital
A Cost of
capital
24% of 100% of Capital
total
capital Miss pricing zone
RAROC-Credit Asset
Cost of capital
RAROC-Incorporate Cross-Sell
Credit RAROC
Note: Industry classification is based on Moodys’ classification.
Reason of industry concentration risk: GDP of a country is usually relies on certain industry. 20080804 Eric — Confidential
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Agenda
1. Brief Introduction of my experience in Credit Portfolio
Management
2. Through Portfolio Analysis to reshape the portfolio
3. Ideas of improving portfolio
20080804 Eric — Confidential
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Defining the objectives of credit portfolio management will help to determine
the trade ideas. No matter which type, recommend to be a ‘semi-profit’ center.
•Challenge may face
•Main focus
Capital management : increase capital Less liquid credit market
Purpose
velocity – Are names available for hedge
Capital relief is the theme
Regulatory – Are the prices attractive
capital Meet regulator’s requirement
– Rarely full capital-relief can be
management
achieved, unless tenor,
underlying, currency are fully
matched
– Taiwan’s regulator is more
conservative on the structure of
structured credit products
Add Diversification through invest in credit Risk verification for the Investment
– Invest in different Countries adds more opportunity
Risk Return diversification effect – Who evaluate the risk
– Usually portfolio unit will set up industry
improvement Performance evaluation for the PSG
specialist and manage portfolio across
countries. – What is the criteria .
Risk identification
– Performance Metric used (EC or
– Utilize Economic Capital
RC)
– KMV’s PM provides trade optimization
function to give users ideas on which
name to long and which name to short
Effect estimation
– Utilize portfolio model to understand the
benefit of hedging and the effect of adding
new names 20080804 Eric — Confidential
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Understanding the ‘risk’ is the key factor of Investing in credit instruments.
Analyzing the available names in the CDS
market
Price of CDS
Short protection
Running the
Combining
portfolio model to
names from
see the impact to
current portfolio
the existing credit
and package it to
portfolio before
PD sell to clients
making decision
Buy protection
Risk Grades
Either based on EDF or in-
house PD model 20080804 Eric — Confidential
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Modern portfolio theory suggests us that we can enhance the portfolio
performance by re-weighting the current portfolio.
Conceptual
Portfolio Performance Enhancement
12% Hedge : Reduce risk / uncertainty
1
-Tool : Buy CDS, Loan Sell,
Insurance, Securitization
Efficient Frontier
10%
Enhance Yield : Invest in Higher Yield
Return 2
given the same ‘risk’
4
8% -Tool : Secondary loan, Sell
2
CDS, CDS Index, securitization.
3 Current Portfolio
1
6% Swap Asset
3
Synthetics : Reduce risk and utilize the
4
4% free up capital to invest in credit.
5% 15% 25% 35%
Risk
20080804 Eric — Confidential
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Issues in developing CPM function
1 Loan origination: 2 Diagnosis: • Decision process need to be
streamlined
• Does CPM has veto • Information of Regulatory capital /Economic Capital/
power over the loan RAROC/EP • Transfer pricing : EL+CapCost or
origination. Market hedge price
• Assets under managed
• Be aware of interest • a Profit center or Cost center
Public listed / Well known name /SME/ Bond/
conflict faces across
CDS/CDO /country/Consumer • Scenario analysis on Portfolio
organization
model to see the effect of risk
• Who owns the asset
mitigations.
2 3 4
1
Diagnos 4
is
Origination Distribution:
Distrib
Credit
Management • Current distribution
Executio
ution
Portfolio channel.
n
Credit Approval
Manage-
Primary Secon- • CDS Market in Asia is
/ Rating •Loan
ment illiquid.
dary
Trading
Market
•Risk • CLO faces the sub-
Market
•CDS
prime crunch.
:RC/EC
Loan pool •CLO
•Return
By countyr
3 :RAROC
Rating
Execution: /EP
• Relationship with trading desk and securitization
desk for both of the hedge and invest in credit
activities.
• Who pay for the cost . 20080804 Eric — Confidential
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