Asset and Liability Management
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Week2Slides.pptxAsset and Liability Management
Fin6102
Ferriter – Spring 2018
Agenda
Review Questions from Last Week
Depository Institutions
Security Brokers and Investment Firms
Insurance
Finance Companies
Overview of Depository Institutions
This chapter recognizes three major FI groups:
Commercial banks, savings institutions, and credit unions
This chapter discusses depository FIs:
Size, structure, and composition
Balance sheets and recent trends
Regulation of depository institutions
Depository institutions performance
Ch 2-3
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Products of U.S. FIs
Comparing the products of FIs in 1950, to products of FIs in 2016:
Much greater distinction between types of FIs in terms of products offered in 1950 than in 2016
Blurring of product lines and services over time and wider array of services
(Refer to Tables 2-1A and 2-1B in the text)
Ch 2-4
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Specialness of Depository FIs
Products offered on both sides of the balance sheet
Offer loans
Asset side
Accept deposits
Liabilities side
Ch 2-5
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Other Outputs of Depository FIs
Other products and services in 1950:
Payment services, savings products, fiduciary services
By 2016, products and services further expanded to frequently include:
Underwriting of debt and equity, insurance and risk management products
Ch 2-6
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Size of Depository FIs
Consolidation has created some very large FIs
Combined effects of disintermediation, global competition, regulatory changes, technological developments, competition across different types of FIs
Ch 2-7
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Largest US Depository Institutions
Ch 2-8
| Company | Banking Assets | Holding Company Assets ($ billions) |
| J.P. Morgan Chase | $2,134.1 | $2,448.0 |
| Bank of America | 1,629.5 | 2,152.0 |
| Wells Fargo | 1,629.5 | 1,720.6 |
| Citigroup | 1,337.5 | 1,829.4 |
| U.S. Bancorp | 414.0 | 419.1 |
| PNC Financial Services Corp. | 343.6 | 354.2 |
| Bank of New York Mellon | 343.6 | 395.3 |
| State Street Corp. | 289.4 | 294.6 |
| Capital One | 254.4 | 310.6 |
| TD Bank | 252.4 | 253.2 |
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Commercial Banks
Largest group of depository institutions
Differ from other FIs in composition of assets and liabilities, as well as regulatory oversight
Large and small commercial banks differ with regards to structure and composition
E.g., larger banks make more commercial/industrial loans and small banks make more real estate loans
Mix of very large banks with very small banks
Ch 2-9
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Structure and Composition
Shrinking number of banks:
14,416 commercial banks in 1985
12,744 in 1989
5,472 in 2015
Mostly the result of Mergers and Acquisitions
M&A prevented prior to 1980s, 1990s
Consolidation has reduced asset share of smallest banks (under $1 billion)
Ch 2-10
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Regulation, Functions & Structure
Functions of depository institutions
Regulatory sources of differences across types of depository institutions
Structural changes generally resulted from changes in regulatory policy
Example: Changes permitting interstate branching
Riegle-Neal Act, 1994
Ch 2-11
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Ch 2-12
Breakdown of Loan Portfolios
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Commercial Banks: Asset Concentration
| Size | 2015 Assets | Percent of Total | 1984 Assets | Percent of Total |
| All FDIC Insured | 14,679.2 | 100.0 | 2,508.9 | 100.0 |
| $100M or Less | 93.5 | 6.0 | 404.2 | 16.1 |
| $100M - $1B | 1,014.7 | 6.9 | 513.9 | 20.5 |
| $1B - $10B | 1,336.8 | 9.1 | 725.9 | 28.9 |
| $10B or more | 12,234.3 | 83.4 | 864.8 | 34.5 |
Ch 2-13
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Structure and Composition of Commercial Banks
Limited powers to underwrite corporate securities have existed only since 1987
Financial Services Modernization Act 1999
Permitted commercial banks, investment banks, and insurance companies to merge
Ch 2-14
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Composition of Commercial Banking Sector
Community Banks
Regional or Superregional
Access to federal funds market to finance their lending and investment activities
Money Center Banks
Bank of New York Mellon, Deutsche Bank (Bankers Trust), Citigroup, J.P. Morgan Chase, HSBC Bank USA
Ch 2-15
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Balance Sheet and Trends
Key trends since 1987
Business loans have declined in importance while securities and mortgages have increased
What influences these trends?
Increased importance of alternative funding via commercial paper market
Securitization of mortgage loans
Temporary effects: credit crunch during recessions of 1989-92 and 2001-02
Ch 2-16
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Commercial Banks, June 2015
Primary assets:
Real Estate Loans: $3,801.9 B
C&I loans: $1,737.6 B
Loans to individuals: $1,301.2 B
Investment security portfolio: $3,953.0 B
Of which, Treasury securities: $2,015.3 B
Credit/default risk is a major exposure
Ch 2-17
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Commercial Banks, June 2015 Continued
Primary liabilities:
Deposits: $11,108.4 billion
Borrowings: $1,578.2 billion
Other liabilities: $339.1 billion
Inference:
Maturity mismatch/interest rate risk and liquidity risk are key areas of exposure
Ch 2-18
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Terminology
Transaction accounts
Negotiable Order of Withdrawal (NOW) accounts
Money Market Mutual Funds
Negotiable CDs
Ch 2-19
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Equity
Commercial bank equity capital
11.26 percent of total liabilities and equity (2015)
TARP program 2008-2009 intended to encourage increase in capital
Citigroup $25 B
BOA $20 B
Through 2015: $245 B in capital injections through TARP
Ch 2-20
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Off-Balance-Sheet Activities
Heightened importance of off-balance-sheet items
OBS assets, OBS liabilities
Earnings and regulatory incentives
Risk control and risk producing
Role of mortgage backed securities
“Toxic” assets
Expansion of oversight to unregulated OTC derivative securities
Ch 2-21
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Major OBS Activities
Issuing guarantees
E.g., letters of credit
Typically contain an insurance underwriting element
Loan commitments
Derivative transactions
Futures
Forwards
Options
Swaps
Ch 2-22
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Other Fee-Generating Activities
Trust services
Correspondent banking
Services generally sold as a package
Types of services offered:
Check clearing and collection
Foreign exchange trading
Hedging
Participation in large loan and security issuances
Ch 2-23
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Key Regulatory Agencies
FDIC
Deposit Insurance Fund (DIF)
Role in preventing contagious “runs” or panics
OCC: Primary function is to charter (and close) national banks
FRS: Monetary policy, lender of last resort
National banks are automatically members of the FRS; state-chartered banks can elect to become members
State bank regulators
Dual Banking System: Coexistence of national and state-chartered banks
Ch 2-24
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Ch 2-25
Bank Regulators
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Legislation, 1927-1956
1927 McFadden Act: Controls branching of national banks
1933 Glass-Steagall: Separates securities and banking activities, established FDIC, prohibited interest on demand deposits
1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs
Ch 2-26
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Legislation, 1970-1978
1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies
1978 International Banking Act: Regulated foreign bank branches and agencies in US
Ch 2-27
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Legislation, 1980 - 1982
1980 DIDMCA and 1982 Garn-St. Germain Depository Institutions Act (DIA)
Mainly deregulation acts
Phased out Regulation Q
Authorized NOW accounts nationwide
Increased deposit insurance from $40,000 to $100,000
Reaffirmed limitations on bank powers to underwrite and distribute insurance products
Ch 2-28
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Legislation, 1987-1989
1987 Competitive Equality in Banking Act (CEBA)
Redefined bank to limit growth of nonbank banks
Focus on recapitalization of FSLIC
1989 FIRREA
Imposed restrictions on investment activities
Replaced FSLIC with FDIC-SAIF
Replaced FHLB with Office of Thrift Supervision (OTS)
Created Resolution Trust Corporation (RTC)
Ch 2-29
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Legislation, 1991
1991 FDIC Improvement Act
Introduced prompt corrective action (PCA)
Risk-based deposit insurance premiums
Limited “too big to fail” bailouts by federal regulators
Extended federal regulation over foreign bank branches and agencies in FBSEA
Ch 2-30
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Legislation, 1994
1994 Riegle-Neal Interstate Banking and Branching Efficiency Act
Permits BHCs to acquire banks in other states
Invalidates some restrictive state laws
Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank
Newly chartered branches permitted interstate if allowed by state law
Ch 2-31
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Legislation, 1999
1999 Financial Services Modernization Act
Allowed banks, insurance companies, and securities firms to enter each others’ business areas
Provided for state regulation of insurance
Streamlined regulation of BHCs
Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions
Provided for national treatment of foreign banks
Ch 2-32
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Legislation, 2010
2010 Wall Street Reform and Consumer Protection Act
Financial Services Oversight Council created
Government gained power to break up FIs that pose a systemic risk to the system
Consumer Financial Protection Bureau created
GAO to audit Federal Reserve activities
Nonbinding proxy vote on executive pay
Trading via clearinghouse for some derivatives
Ch 2-33
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Industry Performance
Economic expansion and falling interest rates through 1990s
Brief downturn in early 2000s followed by strong performance improvements
Record earnings $106.3 billion 2003
Performance remained stable through mid 2000s as interest rates rose
Late 2000s: Strongest recession since Great Depression
Ch 2-34
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Savings Institutions
Comprised of:
Savings Associations (SAs)
Savings Banks (SBs)
Effects of changes in Federal Reserve’s policy of interest rate targeting combined with Regulation Q and disintermediation
Effects of moral hazard and regulator forbearance
Qualified thrift lender (QTL) test
Ch 2-35
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Savings Institutions: Recent Trends
Industry is smaller overall
Intense competition from other FIs
E.g., mortgages
Ch 2-36
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Primary Regulators
Office of the Comptroller of Currency (OCC)
FDIC-DIF Fund
FDIC oversaw and managed Savings Association Insurance Fund (SAIF)
SAIF and Bank Insurance Fund (BIF) merged in January 2007 to form DIF
Same regulatory structure applied to commercial banks
Ch 2-37
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Credit Unions
Nonprofit DIs owned by member-depositors with a common bond
Specialize in small consumer loans
Exempt from taxes and Community Reinvestment Act (CRA)
Expansion of services offered in order to compete with other FIs
Claim of unfair advantage of CUs over small commercial banks
Ch 2-38
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Ch 2-39
Composition of Credit Union Deposits, 2015
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Global Issues
Spread of US financial crisis to other countries
Many European banks saved from bankruptcy through support of governments and central banks
Target interest rates at or below 1 percent
Links to macroeconomic performance
Ch 2-40
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Financial Statement Analysis
Return on equity (ROE): measures overall profitability per dollar of equity
Return on assets (ROA): measures profit generated relative to assets
Equity multiplier (EM): measures extent to which assets are funded with equity relative to debt
Profit margin (PM): measures ability to pay expenses and generate net income
Asset utilization (AU): measures amount of interest and noninterest income generated per dollar of total assets
Ch 2-41
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CAMELS Ratings
Composite 1: Institutions are generally sound in every respect
Composite 2: Institutions are fundamentally sound, but may reflect modest weaknesses
Composite 3: Institutions exhibit financial, operational, or compliance weaknesses
Composite 4: Immoderate volume of serious financial weaknesses
Composite 5: Extremely high immediate or near term probability of failure
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DIs and Regulators
Ch 2-43
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Technology in Commercial Banking
Wholesale banking services
E.g., account reconciliation, electronic funds transfer, electronic billing, cloud computing, etc.
Retail banking services
E.g., ATMs, smart cards, online/mobile banking, tablet banking, loyalty programs, etc.
Advanced technology requirements
Ch 2-44
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