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Commercial Bank Management PDF

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886 views27 pages

Commercial Bank Management PDF

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Margaretisa
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COMMERCIAL BANK MANAGEMENT Peter 5. Rose Texas A & M University io McGraw-Hill . Boston Burr Ridge, TL Tnbuque.1A Madison, WI New York San Francisco St. Louis Bangkok Bogoti Caracas Lisbon London Madrid Mexico City Milan New Delhi Seoul Singapore Sydney Taipei Toronta H A Pp r gE R 9 Orr-BALANCE-SHEET _ FINANCING IN BANKING AND CREDIT DERIVATIVES Learning and Management Decision Objectives ‘The purpose of this chapter iy 10 learn ahowt some of the newer Gnuncial instruments that bankers lave u.cdl in recent years to help reduce the risk exposure of their banks und), in some cases, 10 aid in generating. new sources of fee income and in a funds to make loans and investments. We will view these newes tish-tnanagement ind income-generating insituments from the point of view of the bank manag their key advantages and possible disadvantayes. exploring Introduction As we have seen in the preceding chapters, banks face many Kinds uf risk exposure! Interest rates change and both bank interes! revenues and interest costs are affected as is the value of many bank assets (especially the securities portfolia). Burrowing cus- tomers default on their loans, confronting the hunk with serious credit risks and dimin- ishing the banks expected camings, Added to these problems ure (hie demands of the regulatory community to svengthen bank capital—the most expensive source of Funds for most banks in cider to protect the institution against these and other forms of isk, Bankers have actively sought now ways to reduce their need for raising expensive capital by removing risky assets from their asset portfolio or by contacting away some of their risk exposure. Confronted with these conflicting pressures of risk exposure and the demands of the regulatory community for sironger defenses against risk, bankers in recent ye: have responded by developing and making use of a wide vatiely of risk-manaj wement ‘urortions of this chapter are taken ftom the author's article foewsing wn ell-balance-shuet financing fn The Canadian Banker (V1,12,18) and ate used with periission, 277 28 ban Avert iis Mfanagentent fe niges wud Hen egos erst Bate anal Coe Bish tools These riskemanagemen¢ weupons have includes soch devices as secwiitization of foans, Joan yates, standby creat letters, and credit derivatives af vusiuus kinds, poy ols helped bankers manage risk more effectively, but they sve alst upgned up new sources Of fee Income for hanks and helped them serve their ustomers ¢ ent in Lines when avaitable funding has been scares and costly 10 obra ‘lala a close lok at cand of these Hak rosragtinal and fee NOONE Betsy teols in the sets that follow, only have these newer Securitizing Bank Loans and Other Assets Securitization of « bank's loans and other assets is & simple ide Tier rising mow funds un for reducing a bank's risk exposuse —so- simple, in fact, hat one wonders why was not fully developed until the 1970s and 1980s. Securitizing assets requives « bank to set aside a group of income-eaming assets—such as morigages or consumer loung—and to sell securitics (financial claims) against those assets in the open market (See Fxhibit 9-1.) As the assets pay out—for xample, as borrowing customers repay Exnmer IL ' Securit id Orher Assets into Sources of Hank Funds tine: Fursing Lows a une ral sed froma searitins sales ace digested anto new Tons and other assets forthe bank, | _ Extends loans to ry] Ioreneving eustomers Funes finan securities sales Now hack to the han Bovine and household Bank loan eustorners 1O0Us evidencing the loans. made TOUS from borcowing Sale of packaged imio pools A securities of similar ouns, supported by | und securities that ‘he Foams opresens an inerest made in these pols of ous ine sold wo investors Tavestons: Financial institutions ‘und maividuals “Source: Peer S, Rose, ~The Quest for Fonds: Now Rinstion in New Market." The Cronacve Banker SeplemberCecebee 189 2 ees theet Beam Chageer 9 Ont a Beri satel Creel Devivattren 279 the principal and interest owed on their loans—that income stream flows to the heldets cof the securities, Th effect. burtk Inans are transformed into publivly traded securities, Hor ity pat. the hank receiv 8 bucK the money it expended to xequuire the assets and uses those funds to acquire new assets or 10 cover operating expenses The bank or ather lender whose loans are pooled is called the exeineiar and the ous use then passed ont tw ¢aequired by! ait issuer, who is usually a special purpose ensity (SPE, The SPE. is completely separate trom the ariginator so that if the origina ing lender yoes bankrupt, this event will not affect the ere it status af the louns in the dol. A renstee is appointed to ensure that the issuer fulfills all the requirements of the trinster of loans to the pool and provides all the services promised (including, where stipulated, fulfilling any guarantees or collateral requirements in case a significant pro- portion of the pooled loans are defouited). The trustee collects and disburses to ine vestors any cash flows generated by the pooted loans and temporarily invests any cash generated hy the loans between required investor payment dates, Pooling loans through securitization helps to diversify a bank's credit risk expo Sure and reduces the need to moniter each individual loan’s payment stream, It ¢reates: Liquid assets out of relatively illiquid, expensive-to-sell assets and transiorms these as sets into new sources of capital. Sccuritizations permil banks subject (0 eeonamie downturns in their local areas to. in effect, hold a mare geographically diversified loan portfolio, perhaps countering local losses with higher returns avaitable from gcugraphic areas experiencing mare buoyant economic conditions Securitization is also a tool for managing interest rate risk, making it easier for any indi vidual bank to adjust ils asser portfolio so that the maturity (duration) of its a5- seis more closely approximates the maturity (duration) of its liabilities, Moreover, the bank can earn added fee income by agreeing to service Ihe pack: aged asseas. Usually this means monitoring the borrowers’ performunce in repaying their Joans, collecting payments due, and making sure adequate collateral is posted to Protect holders of any securities issued against those loans, While the bank may con- tinwe to service any assets pledged, it can remove thase assets from its balance sheet, eliminating the risk of loss if the loans are not repaid or if interest rate movements lower their vatue2 (Securitization (ends 19 shorten the maturity of a bank's assets, r- ducing their overall sensitivity to interest rate movernents.) A bank may also’ secure additional earnings based on the spread between the interest rate being eamed on the Securitized assets and the interest rate paid to security holders, which usually is lower. Moreover, taxes may be reduced because of the deductibility of the interest expense incurred when assets are securitized and there is na regulatory tax in the form of de- posit reserve requirements. However, the asscix packaged to back any sectitities issued ‘must be uniform in quality and purpose and carry investment features (such us high yields or reacly marketability) thal are. attractive to investors, step evovimg Toans in the securitizeu pool from the dank’s balance sheet —ean hea vel ps ‘rors a regulatory point a wiew, Regulations generally lic the propnetitw of bunke assets committed 49 Jouns in order ta contto risk exposure. A bank with a relatively high loan-asset ratio can bundle a group af as amd move them off its “snake to nuke the bat kon! Financially stronger: Foal ansets will decline ‘while capita remains the sg-ne, xo the bask's eapial-to-assels saa unpeowes, 280 Hare lt AstetoLacbrlity Management Teebmigees ret Heatying eyainst fuerest Rate tnd Credin fing While some bankers believe that securitization helps a bank gel slang with tess capital (hecause risky assets arc removed from the balance sheet), securitizing |nang may not always reduce a bank's capital requirements as specified by regulators, § ritizations of commercial louns, for example, may cairy the same regulatory capi Ve. quirements for a bank as the original Loans themselves. According to the internationgy capital standards Obasel) agreement between the United States, Cumuda, Japan, ang leading European countries (discussed in Chapter 15), both commercial loans and se, curitized commercial loans can carry a capital requirement as bigh as 8 percent of teie amount, For example, when Joans are sold or securitized and the buyer 18 given re. course to the selling bank if those loans are defaulted, the full value of the loans myst be included itv the bank's capital requirements. ‘As the foregoing paragraphs suggest, securitization of loans ceeates numerous op poctimnities for revenue for the unk choosing this fund-raising alternative. A bank can benefit from the nonnal positive spreud between the average wicld on the puckaged Enans and the coupon (promised) rate on the sceurities issued, capturing, al least a par- rion of the difference in intorest rates between the loans themselves and the. securities issued against the loans as residual income, The securitizing bank or another institu. tion may be able to gain additional incame by servicing the loans pledged being the securities, collecting interest from the loans and monitoring their performance, Many banks have ulso gained added income by selling guarantees ly protect investors who hold loan-backud securities, by advising institutions securitizing their loans on the cor rect procedures, and by providing backup liquidity in case @ securitizing, institution runs short of cash to meet ils obligations to investors. Below is an illustration of a typi. cul securitization transaction and the fees it might generate: ‘Average expected yield on she povled Iuans (aca percent of the tora value of the securitized Yoans), . «18M Promised Fees and payments on these securitized foans might incl of the otal value of the sersrtized loans): he fetlgwing (expressed as u peice + Coupon rule promised to investors who buy lise securities issued against the pool ofloans .. “ a % + Default rate on the pooled loans (often covered 1 bya government or private guaranted or the placeirient of sorne revenues gencrated by the pooled loans in a special reserve to ensure security holders against default) + Fees to compensate a servicing instinution | for collecting payments from the loans in the pool and for monitoring Ure performance of the pooled loans. . case aN 028 + Fees pail for advising on how to set up the seousitized pool af Toans. . . - sienna + Pees pull for providing a liquidity Facility to cover any temporary shortfalls im easlt needed to pay seeunity investors 7 01358 Chagtee Ofettaiance:Sheet Financing in Bunking and Credit Demvatives 281 + Residual interest ir eome tor the securcizing institution (teft over after payment ofall fees 4nd payment of the crupon rate prontised w investors) + M254 + Sum ot all tees, promised payments, and residual interest incime : ay Reginnings of Securitization—the Home Murtgage Market ‘The concept of securitization began in the residential mortgage market of the United States where three fecleral agencies~ the Governreent National Mortgage Association

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