Chances and limits of active credit risk management

bank.uni.hohenheim.de

Chances and limits of active credit risk management

Chances and limits of active credit

risk management g

Prof Prof. Dr Dr. Stefan Kirmße

Managing Partner zeb/

Stuttgart-Hohenheim, February 9 th , 2010


Agenda

0 zeb/ – facts and figures

1 Motivation for transferring credit risks

2 Overview of risk transfer products

3 Application examples

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 2


0 zeb/ – facts and figures

1 Motivation for transferring credit risks

2 Overview of risk transfer products

3 Application examples

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 3


Over the last eighteen years zeb/ has acquired a leading position for providing

advisory services to banks and other financial services companies

Company data (as of: 01/2010)

• Beginning of the business activity: 1992

• 103.2 m EUR of turnover in 2008

• 41 partners

• 645 employees

whereof 315 management consultants and trainers, 195 IT developers and

IT consultants

• Projects in Germany, Austria, Switzerland, Luxembourg, Liechtenstein and

Central and Eastern Europe

• Offices: Berlin, Budapest, Frankfurt/Main, Hamburg, Kiev, Munich, Münster,

Prague, Ulm, Vienna, Warsaw and Zurich

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 4


zeb/ assists enterprises and institutions from the financial service sector, both in

Germany and Europe, in the form of focused consulting

zeb/rolfes.schierenbeck.associates

• Management g Consultingg

(strategic and operative)

• IT Consulting/IT Development

• TTraining i i & Coaching C hi

• Seminars

Focused sectors

Banks and

insurance

companies

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 5


zeb/ is the largest specialist consulting company in Germany measured by

turnover, and is among the top five companies in the financial service sector

Management Consulting companies in comparison

Rank Companies

1 McKinsey & Company Inc. Deutschland, Düsseldorf

2 Roland Berger Strategy Consultants, München

3 The Boston Consulting Group GmbH, München

4 Deloitte Consulting GmbH, Hannover

5 Booz Allen Hamilton GmbH, GmbH Düsseldorf

... ...

16 zeb/rolfes.schierenbeck.associates gmbh, Münster

17 Arthur D. Little GmbH, Wiesbaden

18 Management Engineers GmbH & Co. KG, Düsseldorf

19 MC Marketing Corporation Gruppe, Bad Homburg

20 Towers Perrin Inc., Frankfurt am Main

21

Kienbaum Management Consultants GmbH, Gummersbach

Turnover in Germany

Number of employees

in million EUR

in Germany

2008 2007 2008 2007

645.0 630.0 2,300 2,000

398.0

369.0

286.0

262 262.0 0

...

365.0

361.5

266.0

252 252.0 0

...

840

1,510

1,156

600

790

1,370

830

580

79.4 77.5 605 547

22 dd-fine fine GmbH, GmbH Frankfurt am Main 48 48.2 2 37 37.3 3 235 200

Source: Lünendonk GmbH, Bad Wörishofen, http://www.luenendonk.de/management_beratung.php, 2009

79.0

77.0

57.0

78.5

59.0

46.0

...

235

190

250

...

250

155

64.0 61.7 285 287

62.0 58.0 350 330

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 6

195


Since its foundation, zeb/ has achieved an average annual increase of turnover

of > 20%

zeb/ growth since its foundation

Turnover

in m EUR

100

80

40

Financial year 2008

103.1 m EUR turnover1 ,

674 employees

Employees

0

0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Foundation in Münster by

professors Rolfes and

Schierenbeck

1 Gross turnover (including additional costs)

Offices in

Frankfurt

and Berlin

Offices in Munich

and Warsaw

Integration of

SAP expert

ITE computence

Offices in Zurich

Development in the IT field and dVi Vienna 2007/2008: offices in

Hamburg, Kiev,

Prague, Budapest

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 7

500

250


zeb/ specialises in consulting for all companies in the financial service sector

zeb/ areas of competence

Sales

Private Customers

• Sales strategies

• Support concepts

• Sales management

• Training/Coaching

Corporate Customers

• Sales strategies

•Support pp concepts p

• Sales management

• Training/Coaching

Private Banking

• Sales strategies

•Support pp concepts p

• Sales management

• Training/Coaching

• Restructuring/cost management

• IT strategies and IT management

• IT architecture management

• IT governance and IT management

• Coaching board members and management staff

• Sales training in all distribution segments

• Specialist training

Strategies

• Re-assessment of strategy

• Growth strategies

Production Steering

Organisation and Transformation

• End-to-end value chain management:

- PProcess redesign/industrialisation

d i /i d t i li ti

- Process/quality management

- Outsourcing/shared services/financial

service providers

- Credit processes/service providers

- Security processes/service providers

- Payment/card/current account/savings

account processes/service providers

- Staff and administrative processes/service

providers

• Merger and integration management

IT

Training and further development

• Change management

• Accounting

• Financial Controlling

• VValue-oriented l i t d Corporate C t

Management

• Treasury Management

• Capital Markets & Investment

Banking

• Asset & Wealth Management

• Compliance & Corporate

Governance

• Supervisory Regulations

• Reportingg

• Credit Decision & Control Engine

• Methods & Models

• Risk Management

• Project management

• Development and implementation

of bank steering software

• SAP consulting

• Board and expert panels

• In-house seminars

• Sales/Controller Academy

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 8


References of zeb/ point out the strong market position in the financial services

area in all sectors in Germany

Selected clients of the zeb/ group in Germany

Saving banks and

fi financial i l groups

Large, regional and

private i t banks b k

Cooperative p institutions Insurance companies p

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 9


For a long period of time, zeb/ has been active within the leading banks in Austria

and Switzerland – CEE is the growth market of the future

Selected clients of the zeb/ group abroad

Switzerland/

Austria

CEE Western Europe

Li Liechtenstein ht t i

LGT Bank in Liechtenstein

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 10


0 zeb/ – facts and figures

1 Motivation for transferring credit risks

2 Overview of risk transfer products

3 Application examples

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 11


With regard to risk types to be managed, credit risks play a special role in the

bank-wide context

Credit risks in the bank-wide context

Credit risks

• Result from

transactions giving

rise to actual, actual

potential or future

claims against

business partners

• Credit risk is the

hazard of losing

money bbecause

business partners do

not meet their

contractual payment

obligations at all or

not in due time

Market risks

Banking risks

• Uncertainty of

changes in market

prices

• Examples: Interest

rates, share prices,

exchange rates,

commodity y prices

Operational Liquidity

risks

risks

• Losses related to

employees,

contractual

arrangements and

documentations,

technology,

infrastructure

failures, disasters or

other external

factors

• They also include:

legal and regulatory

risks

Bank-wide risks

• Threats to

profits and

equity because

of a potential

inability to meet

payment

obligations g in

due time without

incurring

unacceptably

high losses

Other banking

risks

• Sales/business

segment risks

• Refinancing risks

• Productivity risks

• Real estate risks

• Equity interest

risks

Other risks

• Strategic risks

• Reputational risks

• Tax risks

• Outsourcing risks

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 12


Credit risk usually is the biggest risk category of banks – in spite of marked

differences in business models

Share of individual risk categories in the bank-wide risk position1

Deutsche Bank Commerzbank

Other 3% risks

18%

Operational

risks 18%

2 3%

Market risks

39%

39%

Operational risks 4%

40% Credit risks

40%

Other 6% risks

Operational 11%

risks 11%

2 6%

Market risks

35%

35%

Landesbank Baden-Württemberg Norddeutsche Landesbank

6%

Other risks 20% 4%

3% 2 20%

Operational risks 4%

Market risks

11%

11%

65%

Credit risks

65%

Market risks 3%

Other risks 2 6%

87%

48% Credit risks

48%

Credit risks

87%

1 Share of risk categories based on the economic capital and own funds requirements. All information as of 31 Dec. 2008.

2 Including risks from securitisation and equity interests and business risk. Details for LBBW: Risks from securitisation (15% of bank-wide risks), equity interests (5%).

Source: Annual reports, disclosure reports, zeb/research.

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 13


Banks have three main instruments to control credit risks – risk avoidance, risk

mitigation and risk transfer

Main approaches to controlling risks in credit business

Risk

control

Risk avoidance

Risk mitigation

Risk transfer

OOptions ti

Complete refusal to accept risks resulting from

certain

• transaction types

credit segments (sectors, countries, ...)

Reduction of credit risks that already exist or will

be taken in the future by means of

risk sharing and collateralisation

risk i k li limitation it ti

risk diversification

Transfer of risks taken to third parties

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 14


In lending, however, there is a basic conflict of objectives that cannot be

satisfactorily resolved through risk avoidance and risk mitigation

Conflicting objectives: Specialisation vs. diversification in lending

Value creation chain and success factors

Sales

• Detailed knowledge of customers

and closeness to customers

• Customer care intensity and quality

• Specialisation/focus on customer

segments, products, sectors,

regions, etc.

Specialisation

Current solution to the

conflict of objectives

Risk disadvantages for the bank

• Portfolio is worse diversified and involves

higher risks than the one of competitors

• Higher capital required for covering risks

• Strongly varying valuation results

• Worse external rating, refinancing

disadvantages

Production Passive

Conflicting

objectives

control by

structural

limits (buy (buy-and- and

Controlling

Diversification

hold model) Return disadvantages for the bank

• Especially for good counterparties, terms and

conditions are not competitive (because of

• Well-diversified portfolio (no

high equity capital costs)

Risk

manage-

ment

focus on specific

counterparties, sectors,

regions, etc.)

• Size as a prerequisite p q of

sufficient portfolio

diversification

• In regional lending, growth potentials are

limited (e.g. by sector limits, individual

customer limits)

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 15


The resolution of this conflict between objectives rather lies in the separation of

credit extension and risk assumption and risk transfer to third parties

Harmonisation of return and risk objectives

Objective

Maintaining the successful specialisation /

focused strategy in sales while permitting an

adequate diversification of the credit portfolio

even if the portfolio is small

Specialisation in parallel with

diversification

Possible solution

Credit risks have to be uncoupled from the

counterparty (customer relation) and actively

spread across a wider group of bearers of risk

Active credit portfolio management

(credit treasury)

Actions required:

1 Creating the basis for the structured

transfer of credit risks

2 Implementing targeted measures for

improving portfolio diversification

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 16


0 zeb/ – facts and figures

1 Motivation for transferring credit risks

2 Overview of risk transfer products

3 Application examples

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 17


Overview of possible instruments for transferring credit risks

Instruments

Consortium loan

(meta-credit)/

syndication

Guarantee/

credit

insurance

Possibility to

manage...

Individual Portfolio

risks risks

Yes No

Yes No

Loan sale Yes No

Credit

derivatives

Counterparty

risk

Balance-

sheet pos.

Yes In part.

Securitisation

AAA

BBB

C

Yes Yes

Portfolio

Advantages Disadvantages Assessment

• Familiar product

• Simple structure (metacredit)

• Standardised product

(standard meta)

• Familiar product

• As a rule, simple structure

• Simple structure

• Tradable (e.g. Deutsche

Kreditbörse)

• Also possible for NPLs

(e g BAG Hamm)

• High transaction costs

• As a rule, only for good ratings

• Focus of syndication on initial

loans

• Not tradable

• High transaction costs

• As a rule, only for good ratings

• Not tradable

• At present, only tradable to a

highly limited extent

• High transaction costs

• Especially standard meta well

suited for eliminating size risks

for individual good rating

classes

• Only suitable to a limited extent

for transferring counterparty

risks

• At present, only usable to a very

limited extent

• In future, trading/exchange

places conceivable in a network

• Also suitable for NPLs

(e.g. BAG Hamm) • Also suitable for NPLs

• Simple structure

• Tradable at relatively low

transaction costs

• High level of

standardisation

• No impact on customer

relations

• Flexible, individual

structuring options

• Portfolio risks transferrable

• Also suitable for small

portfolios owing to multiseller

structures

• Liquid market only for big

companies

• Complex products

• Transaction cost still very high

• NNon-transparent t tpricing i i

• High requirements for banks

(data, processes, staff,

systems...)

• As stand-alone products only of

limited suitability for primary

banks

• In future, trade in credit deriva-

tives conceivable in a network

• Important elements of complex

securitisation structures

• Very well suited for transferring

counterparty risks

• Also suitable for NPLs

• Also very well suited for small

banks owing to multi-seller

structures

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 18


By means of a meta-credit, large credits can be included in the portfolio without

creating a size-class risk

Process and structure of a standard meta-transaction illustrated by the example of DZ Bank

Schematic process Activity Responsibility

Primary bank

1

2

- BVR II rating

- Geno-FBS

- ...

...

BWA

Rating

Source: Dexheimer, U. (2004), in: Zeitschrift für das gesamte

Kreditwesen (ZfgK).

Initial Primary processing banksystem

Preliminary decisionmaking

tool

4

3

5

1

2

3

4

Explanations on the transaction

5

Input of application data and risk

parameters

Connection to data supply

systems/auto. data transfer

Risk assessment and (preliminary)

decision (including price indication)

Document transfer and manual risk

analysis/plausibility check of

unclear inquiries

Printout and dispatch of guarantee

contract; account opening and

posting

Primary bank

System

Preliminary

decision-making tool

Primary bank/

DZ Bank analyst

DZ Bank analyst

• DZ Bank insures the blank portion through a deficiency guarantee

• No contractual relationship between borrower and DZ Bank

• Prerequisites include:

- BVR II rating

- Min. € 100,000 EUR, max. € 1 million & max. 50% of the default amount (EADxLGD)

- Terms of 1 - 5 years, prolongation possible

- Bullet or linear repayment, no early repayment

• In case of default, DZ Bank directly pays 50% of the guarantee; the rest is settled after

realising the collateral

• Guarantee fees range from approx. 0.6 to 1.7% p.a. depending on the rating and term

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 19


By means of credit derivatives, credit risks can be isolated from the reference

asset and transferred

Definition: Credit derivatives are financial derivatives that allow a party to the transaction (the risk seller) to

separate the credit risk from a reference asset (credit, (credit security, security etc.) etc ) and to sell it to another party

(the risk buyer) against payment of a premium.

Before: After the transaction:

Bank A

Liquidity

component

free of credit risk

Credit risk

component

Reference asset

Bank A

Risk seller

Liquidity

component

free of credit risk

Credit risk

component

Credit

derivative

Bank B

Risk buyer

Credit risk

component

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 20


Possible applications of individual credit derivatives are illustrated by the

following examples

1

Industrial bond of

XY Ltd.

of EUR 25 million

Bank A holds a EUR-denominated industrial bond with a nominal value of

EUR 25 million with a residual maturity of 5 years. The bond has a yield

of 5.95%.

Hedging purpose: Rating-related decline in the bond’s price

2

Industrial bond of Bank A holds a EUR-denominated EUR denominated industrial bond with a nominal value of

YZ, Inc.,

EUR 50 million with a residual maturity of 3 years. The bond has a yield

of EUR 50 million of 4.62%.

Hedging purpose: Market and rating risk of the bond

3

Large loan to

Chemical Chemical, Inc. Inc

Bank A is the principal bank of Chemical, Inc. At present, the company

has loans of EUR 50 million. To fund investments required q for further

expansion, Chemical, Inc. wishes to take out another bullet loan of EUR

15 million that, however, would exceed the risk limit defined internally for

Chemical, Inc.

Hedging purpose: Keeping the customer; preventing risk

concentration

Credit spread

put option

Total return swap

Credit default swap

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 21


Bank A can transfer a rating-related decline in the bond’s price in full or in part by

buying a credit spread put option

1

Industrial bond

of XY Ltd.

of EUR 25 million

Determination of credit spread:

Yield of the 5-year EUR-denominated industrial bond

Yield of a 5-year government bond (risk-free)

5.95%

5.50%

Credit spread: 0.45% or 45 basis points

Bank A

(i (risk kseller) ll )

Buyer of the

put option

Yield = 5.95%

Industrial bond

of XY Ltd. Ltd

Premium payment

Performance when the option p is

exercised by the option’s buyer (Bank A)

Delivery right

Counterparty

(i (risk kb buyer) )

Seller of the

put option

Credit spread p options p are options p whose strike pprice is defined by y a specific p credit spread. p

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 22


A total return swap transfers both the credit risk and the interest rate risk of a

bond to the counterparty

2

Industrial bond

of YZ, Inc.

of EUR 50 million

Bank A

(risk seller)

Interest

payments

Industrial bond

of YZ, Inc.

Total return swap

• unconditional forward transaction

Entire cash flow of the underlying +

valuation gains (upon maturity)

Variable interest rate + spread +

valuation losses (upon maturity)

Counterparty

(risk buyer)

• on a swap of the total return (all cash flows, value changes) of the underlying against variable

interest payments free from credit risk (as a rule rule, LIBOR + spread)

• Settlement payment is calculated as the difference between the underlying’s market value

at maturity and at the start of the swap contract.

• Bank A is protected against valuation losses because of rising market interest rates and

deteriorated ratings, but cannot benefit from a rise in the bond’s price any more.

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 23


A credit default swap prevents an undesirable risk concentration, while

maintaining the customer relationship

3

Large loan to

Chemical, Inc.

Credit

relationship

Bank A

(risk seller)

Interest

payments

Chemical, Inc.

Occurrence of the credit event when

– The rating falls below an agreed rating

level

or

– Ongoing payments are discontinued

or

– Composition or bankruptcy proceedings

are initiated

Premium payment

(x BP per year)

Payment upon the occurrence

of the credit event (“default”)

at Chemical, Inc.

Default payment as

Counterparty

(risk buyer)

– Binary payment (fixed settlement amount)

or

– Cash settlement

(settlement payment in the amount of loss

in value resulting from the credit risk)

or

– Physical settlement

(delivery of the underlying at a price fixed

upon contract signature)

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 24


The basic idea of securitisation transactions is to pool and securitise reference

assets into bonds

Reference assets

Pooling

Securitisation

Vertical slicing

Syndication of the entire portfolio (like a “cake” – each “slice” has the

same properties as the entire “cake”)

Structuring/

slicing

into bonds with the

same rating

Tranche 1

Tranche 2

Tranche 3

...

Tranche n

Horizontal slicing

The individual tranches have different properties (like a “cake” – one

“slice” is made up of the “bottom”, and another “slice” is made up of the

“icing”, etc.)

“Waterfall Waterfall principle” principle

Structuring/

slicing

into bonds

with different

ratings

Sennior

tranches

Mezzzanine

trannches

AAA tranche

AA tranche

A tranche

Interest and

redemption

BBB tranche Payment

Equity tranche

defaults

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 25


By combining individual assets in an asset pool, individual risks are

“automatically” diversified

Very high risk of

Each bank faces a high risk of

The combined occurrence of

unexpected p losses

very y high g losses

all three events is less likely y

lower risk of very high

losses

Bank A Bank A





Avian influenza


Bank B Bank B

Swine fever


Bank C Bank C

BSE

Specific event risks




Risk

diversification

Diversified portfolio of risks

assumed by Banks A, B and C

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 26


Different securitisation types can be grouped by the type of their reference asset

Asset-backed securities by asset class

Asset-backed

securities

(ABS)

ABS Debt

in a narrower sense CDO

Credit card claims

Consumer loans

Loans

CLO

Mortgage-backed

securities

MBS

Residential mortgagebacked

securities

RMBS

Leasing claims

Commercial mortgage-

Bonds

backed securities

Future income CBO

CMBS

Reference assets Housing

loans

RMBS CMBS ABS CDO

Commercial Consumer loans,

mortgage g g credit card claims, , etc.

Bank loans,

bonds

Number of assets Many Relatively few Many Few

Average asset volume Low Medium Very low High

Liquidity of secondary market High Medium to high Medium to high Low to medium

Rel Rel. spread per rating class Low Low to medium Medium to high High

Collateralised Loan Obligations

Rel. risk per rating class Low Low to medium Medium to high High

Collateralised Bond Obligations

Market price fluctuation Low Low to medium Medium to high High

Collateralised Swap Obligations

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 27


0 zeb/ – facts and figures

1 Motivation for transferring credit risks

2 Overview of risk transfer products

3 Application examples

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 28


The main characteristic of classical securitisation is the sale of the underlying

asset portfolio

Structure of classical securitisation (true sale)

Reference portfolio

Originator/

bank

Sale of assets

Issue revenue

minus cost

Trustee

SPV

ABS sale

Issue revenue

AAA tranche

AA tranche

A tranche

BBB tranche

Credit enhancer Swap partner First loss tranche

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 29


The main characteristic of synthetic securitisation is the transfer of the asset

pool’s credit risk by means of credit derivatives

Structure of synthetic securitisation (funded)

Originator/

bank

Reference portfolio

Premium

Hedging of

default risk

Super senior swap

Trustee

CDS/CLN SPV

Collateral

Purchase with

issue revenue

CLN sale

Issue revenue

OECD bank

(AAA implied)

AAA tranche

AA ttranche h

A tranche

BBB tranche

First loss tranche

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 30


Smaller banks have access to securitisation especially within the framework of

multi-seller transactions

Multi-seller transaction illustrated by the example of synthetic multi-seller securitisation

Primary bank A

reference portfolio

Primary bank B

reference f portfolio tf li

...

Primary bank M

reference portfolio

...

Primary bank Y

reference portfolio

Primary bank Z

reference portfolio

Premium

CDS/CLN

Hedge against

default risk

Multi-seller

securitisation

service provider

Super senior swap (e.g. CDS)

Trustee

SPV

Collateral

Purchase with

issue revenue

ABS sale

Issue

revenue

OECD bank

(AAA implied)

AAA tranche

AA tranche

A tranche

BBB tranche

First loss

tranche

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 31


In so-called closed-loop securitisation models, risks are pooled and re-transferred

to the participating primary banks

Illustrative structure of a multi-seller securitisation loop

Own account

Credit portfolio

Loan

R: 2

I: Textiles

Own account

Credit portfolio

Loan

R: 2

I: Textiles

Own account

Credit portfolio

Loan

Rating: 2

I: Construction

Bank A Bank A

BBanks k ttransfer f th their i risks i k tto a risk i k pool l th that t refinances fi

those risks, for example, by a credit-linked note...

Own account

AA loans

Industry mix

Credit portfolio

Bank B SPV Bank B

Bank C

Portfolio of

reference loans

Loan

Bank A

Loan

Bank C

Loan

Bank B

Credit-linked note

1. AAA tranche

2. AA tranche

3. A tranche

...the pool sells the note to the banks (own account)

in individual tranches with diversified risk

Own account

AA loans l

Industry mix

Credit portfolio

Own account

AA loans

Industry mix

Credit portfolio

• The banks’ total assets do not change

• Th The banks’ b k ’ credit dit portfolio tf li decreases d while hil the th own account t increases i proportionately ti t l

• The sectoral cluster risk is translated into a sectorally diversified risk “diversification return”, i.e. lower risk

with regard to value at risk and, as a result, lower equity capital cost

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 32

Bank C


Example 1: Provide-VR transactions – securitisation of residential construction

loans

Transaction structure of “Provide VR 2002-1”

Servicing

95.2%

4.8%

Servicing

C

L

I

H

S

VR Kreditwerk

DG HYP

R

e

t

u

r

n

5 credit dit

co-operatives

CDS premium

CDS premium

Compensation

of

realised

loss

Senior

credit

default swap

counterparty p y

Compensation

of

K

f

W

CCredit-linked dit li k d

note

realised loss

Return

Interest +

PROVIDE

VR 2002-1

repayment

Compensa-

SPV

RRepayment t

./. loss

tion of

realised loss

compensation

Reduction of CLS

Volume: € 70.8 million

Credit-linked

note

Return

Interest +

repayment

Compensation

of

realised loss

Reduction of

CLN

R

M

B

S

A+

A

B

I

N

V

E

S

C T

O

D

R

E S

F

Source: DG Hyp

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 33


Example 2: Savings banks’ credit pool “Hessen-Thüringen II” – closed-loop

transaction for commercial lending by savings banks in Hesse and Thuringia

Basic structure of the credit pooling transaction

Administrator (Helaba) Arranger (Helaba)

Originators Special purpose vehicle Investors

Savings bank 1 Originator credit

(Opus Sigma Ltd.)

Savings bank 1

default swap

Savings bank 2

Credit risk transfer

Savings bank 2

1 Investor credit

default swap

Credit risk transfer

(max. ( volume of € 4 mn) )

. . .

Savings bank 18

Corporate customers of

savings banks

Premium (risk-dep.)

Transaction cost

Plausibility checks

Synthetic credit

risk pool

Volume: € 70.8 million

Audit agency

Premium (volume-dep.)

Loan pool committee /

arbitration board

1 The originators’ settlement amount ranges from € 250,000 to € 10,000,000 and corresponds to a maximum of 60% of the specified blank portion of a counterparty.

Source: Landesbank Hessen-Thüringen (Helaba).

. . .

Savings bank 18

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 34


Example 3: VR-Circle 2005-1 – Closed-loop transaction for commercial loans in

the co-operative FinanzVerbund

Basic structure of VR-Circle as closed-loop model

Collateral takers Collateral providers

13 credit co-

Credit risk pool

(SPV)

operatives (CCs)

Risk transfer by

CLN Bank A

SPV CLN

CC CLN

CLN Bank B

. .

Source: DZ Bank.

CLN Bank J

Synthetic

credit risk pool

Volume: € 56.7 million

Risk transfer by

SPV CLN

Rating differences between the individual CC’s CLNs and the SPV’s CLN are compensated by

pricing (spreads).

Loan

SPV CLN

Credit co-operative

Refi

CC CLN

Equity

13 credit co-

operatives

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 35


Summary of potential advantages resulting from active participation in credit risk

transfer transactions

Risk seller Risk buyer

Reduction of a bank’s individual

concentration risks (size classes, individual

borrowers, industries, regions, countries,

products, collateral types...)

Reduction of the bank’s business risk

Reduction of regulatory capital requirements

Decrease of result volatilities in the P&L

account

Decrease of potential maximum losses

Wider leeway for the bank (by reducing the

utilisation of its risk-bearing capacity, limits

and large g exposure p limits) )

Targeted control of the risk/return profile of

the bank; increase in the bank’s profitability

Favourable refinancing through indirect

access to the capital market

...

Wid Wider lleeway ffor th the bbank k on account t of f new

asset classes

Targeted risk diversification through the

acquisition of securitised assets (regional

diversification without abandoning the regional

principle)

Above-average return in comparison with

original g lending g

...

University of Hohenheim zeb/rolfes.schierenbeck.associates Active credit risk management - 36


Your contact:

Prof. Dr. Stefan Kirmße

Managing Partner

E-mail: SKirmsse@zeb.de

Phone: +49.251.97128-0

Fax: +49.251.97128-101

zeb/rolfes.schierenbeck.associates

Office Münster

Hammer Str. 165

48153 Münster

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