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MANAGING BANK RISK

MANAGING BANK RISK. BARBARA FAVA, PFM ASSET MANAGEMENT JUNE MATTE, PUBLIC FINANCIAL MANAGEMENT JIM MATTEO, UNIVERSITY OF VIRGINIA. Market Capitalization (Billions). Change in Market Value. Query to Bank. Dear Sirs,

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MANAGING BANK RISK

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  1. MANAGING BANK RISK BARBARA FAVA, PFM ASSET MANAGEMENT JUNE MATTE, PUBLIC FINANCIAL MANAGEMENT JIM MATTEO, UNIVERSITY OF VIRGINIA

  2. Market Capitalization (Billions) Change in Market Value

  3. Query to Bank Dear Sirs, One of my checks was returned from your bank marked ‘insufficient funds’. In view of current developments in the credit market, does that refer to me or to you?

  4. Credit Rating Trends Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Oct 2012 • Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity. • Source: Bloomberg Finance

  5. Risks to the University • Financial • Loss of Principal • Insufficient Liquidity • Access to Credit Markets • Operational • Opportunity Cost

  6. Cash & Investment Exposure Investments • Principal Risk • Diminished Market Value • Loss of Credit Enhancement • Liquidity • Opportunity Cost • Custody Cash • Deposit Balances • Liquidity • Investment Sweeps

  7. Investment Custody

  8. “Your Purchasing Card is fine. I’m just checking that your bank hasn’t expired!” 8

  9. Operational Risk • Purchasing Card • Merchant Card Processing • Campus Card • Payroll Card • On Campus Branch/ATM

  10. Enterprise Management • Diversity of instruments, parties and potential credit quality • New paradigm for thinking about banking partners • Fewer highly rated players • Many new entrants in new roles • Evolution in types of debt instruments available driven by changes in market

  11. 11

  12. Letter of Credit Provider Ratings as of October 2012 • Lowest rating of Standard & Poor’s, Moody’s and Fitch shown. Chart labels show Standard & Poor’s ratings for simplicity. • Source: Bloomberg Finance

  13. Manage Risk Across the Spectrum Letters of Credit/Credit Enhancement/Liquidity • Put Risk • Trading Spreads • 2a7 Issues Swaps • Counterparty Risk Lines of Credit Direct Placements • Acceleration Risk • Cross Default

  14. Hierarchy of Credit Bank Credit Quality Bank Credit Quality BBB/Baa DirectPlacements A-/A3 A Lines of Credit A+/A1 AA-/Aa3 Swaps AA/Aa AA+/Aa1 Letters of Credit/Credit Enhancement/Liquidity AAA/Aaa

  15. Hierarchy of Credit Bank Credit Quality BBB/Baa DirectPlacements A-/A3 A Lines of Credit A+/A1 AA-/Aa3 Swaps AA/Aa AA+/Aa1 Letters of Credit/Credit Enhancement/Liquidity AAA/Aaa

  16. Hierarchy of Credit Bank Credit Quality BBB/Baa Direct Placements A-/A3 A Lines of Credit A+/A1 AA-/Aa3 Swaps AA/Aa AA+/Aa1 Letters of Credit/Credit Enhancement/Liquidity AAA/Aaa

  17. Hierarchy of Credit Bank Credit Quality BBB/Baa Direct Placements A-/A3 A Lines of Credit A+/A1 AA-/Aa3 Swaps AA/Aa AA+/Aa1 Letters of Credit/Credit Enhancement/Liquidity AAA/Aaa

  18. Letters of Credit • Facility expirations in 2011 had minimal impact • Good pricing • Low VRDB issuance • Lots of competition • Overall supply and VRDBs supply is low • Banks no longer requiring other treasury service relationships • Tenors are typically 3 years or less

  19. Direct Loans • Borrowers opting for direct loans instead of public sale • Lower transaction costs • Easier implementation • No credit ratings • No public disclosure • Longer tenors for variable rate transactions (4-10 years) • Fixed rate typically sold with 20-30 loan and mandatory tender in 4-10 years

  20. Direct Loans Share VRDBs Risk • Bank renewal/Refinancing Risk • Obligation to Repay Loan Accelerates at Term • Many issuers do not have cash on hand or budget flexibility to cover accelerated repayment • Immediate acceleration due to rating or default triggers • Unknown costs related to changing regulatory environment Source: Moody’s Investors Service

  21. Direct Loans Reduce Some Risk • Alternative to Variable Rate Demand Bonds • Increases availability of liquidity at renewal • Limited refinancing risk • For VRDBs, failed remarketing can occur at any time • Credit deterioration of bank or general market dislocation could result in failed remarketing of VRDBs Source: Moody’s Investors Service

  22. Existing Swaps • Continued focus on counterparty risk • Understand collateral thresholds • Consider replacing counterparties • Understanding Additional Termination Events (ATEs) • Treatment of swaps in debt restructuring • Review documents to see whether swap is tied to existing debt structure (i.e. tied to current LOC provider)

  23. “LOOKS SOLID ENOUGH TO ME!”

  24. Holistic Approach • Cash, Investments, Debt, Operations • Understand enterprise risk • Diversify • Balance Credit Quality, Cost, Service and Institutional Exposure

  25. Bank Risk Matrix - Debt

  26. Bank Risk Matrix - Investment

  27. Bank Risk Matrix - Operations

  28. A Case Study in Managing Bank Risk

  29. Risk Management Efforts

  30. U.Va. Treasury Dept. RM • Adopt a Risk Mgmt. Approach • Identify Risk Events • Score Risks • Develop Risk Response • Measure and Monitor Risk

  31. 1. Adopt a RM Approach COSO’s ERM – Integrated Framework http://www.coso.org/documents/coso_erm_executivesummary.pdf

  32. 2. Identify Risk Events

  33. 2. Identify Risk Events

  34. 3. Score Risk Exposures

  35. 4. Develop Risk Response • Retention • Insurance • Avoidance • Mitigation

  36. 5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Debt (Pre-2008)

  37. 5. Measure and Monitor Risk U.Va. Bank Risk Matrix - Debt

  38. 5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments (Pre-2008)

  39. 5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Cash and Investments * Pro-Rata Share of Mutual Fund Holdings

  40. 5. Measure and Monitor Risk U.Va. Bank Risk Matrix – Operations (Pre-2008)

  41. U.Va – What Next? • Diversify Operating Risks • Explore better ways to measure risk • Use risk register to prioritize work • Find natural areas of avoidance • Implement monitoring approach

  42. QUESTIONS?

  43. Contact Information Barbara Fava, PFM Asset Management favab@pfm.com June Matte, Public Financial Management mattej@pfm.com Jim Matteo, University of Virginia jsm6y@virginia.edu

  44. PFM Disclosures The material presented by PFM Asset Management and Public Financial Management (PFM) is based on information obtained from sources generally believed to be reliable and available to the public, however PFM cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation.  All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control.  Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities.

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