Session 5 August 22, 2012


. ISDA; ISDA on Greece [see]


. See Michael Dooley, David Folkerts-Landau and Peter Garber: "An Essay on the Revived Bretton Woods System", NBER Working Paper 9971, 2003

. In February 2012, the stock of Central bank liquidity swaps was at $109.1 billion [see]. It now stands at $30 billion [see].
____________

Credit Default Swaps / Futures Markets


. CDS prices from Markit

. Federal Republic of Germany [see]. Note the change created by the Lehman Brothers crisis. As the flight-to-safety intesified with the worsening Eurozone crisis, CDS prices climbed. 

. Russian Federation [see]. A remarkable story. The country is perceived by the CDS market as very stable; oil prices are a key to Russia’s CDS prices. Look, on the longer-term chart, at what happened in 2009.


. Republic of Argentina [see]. Argentina defaulted on its sovereign debt in late 2001; since then, the country was unable to issue new debt at reasonable interest rates. Maybe the highest CSD prices in the world!


. CME VIDEO
____________

BALANCE SHEET EXERCISE

AM | @MackinlayEuruni


QUESTION. READ FIRST AND ‘LOCATE’ PROBLEMS IN THE BALANCE SHEET: DOES IT AFFECT ASSETS? DOES IT AFFECT LIABILTIES? DOES IT AFFECT BOTH?. AS YOU PROVIDE ANSWERS, WE PLOT THE POINTS INTO THE BALANCE SHEET.

(1) “Many banks are struggling to fund themselves as Europe’s debt crisis deepens” (David Oakley: “CDS highlights funding worries”, Financial Times, October 5 2011).

(2) “Austrian banking supervisors have instructed the country’s banks to limit future lending in their eastern European subsidiaries … The government is concerned about losses in eastern Europe –where they are the biggest lenders- and their exposure to Italy … Erste Bank, Raiffesen Bank and Bank Austria have a CEE exposure that exceeds Austria’s GDP”. (Eric Frey: “Austrian banks ordered to limit central and east Europe exposure”, Financial Times, November 22 2011).

(3) “Many European banks have been shut out of traditional funding markets in recent months, forcing them to rely on central banks for liquidity or to become more creative in obtaining new financing amid market turmoil. Accordingly, some of the strongest UK banks are providing strained European lenders shut out of global funding markets with large amounts of financing. The deals average €200-€500m in size, with maturity dates of two to 10 years. However, amounts of up to €1bn have also been heard. ‘Haircuts’, or collateral taken to protect the lender from adverse movements, were very high, at 15 to 25 per cent or more”. (“Tracy Alloway: “Europe’s banks strike funding deals”, Financial Times, November 24 2011).

(4) “Some banks in countries such as Spain and Italy are finding it harder to secure euro funding from conventional sources amid concerns about a possible Greek sovereign debt default, and in the face of deep skepticism from foreign banks. One measure of the pressure on Spanish banks in particular was their net borrowing from the European Central Bank, which increased sharply to average €6992bn in August, from €52.05 in August, according to figures from the Bank of Spain” (Victor Mallet: “Small banks remain in need of funding”, Financial Times, October 5 2011).

(5) “The onslaught on European banks is unremitting. In the latest setback for banks in Europe, Moody’s Investors Service has put the subordinated debt of nearly 90 per cent of them under review for a possible downgrade. No surprises here: European sovereigns have limited appetite or ability to support them, let alone bondholders. But the warning highlights the risk of a European credit crunch as banks shrink assets and as they struggle to fund those assets”. FROM THE CHART: Italy’s Unicredit pays a 700 basis point spread in the interbank market; Santander is at 480 bps, while Barclays stands at 201 bps. (Lex: “Euro bunch of losers”, Financial Times, December 1 2011).

(6) “Mario Draghi, ECB president, told the European Parliament last week: We have observed serious credit crunch tightening which, combined with a weakening in the business cycle, does not bode at all well for months to come. Small and medium-sized companies are being the hardest hit. The most important thing for the ECB is to repair the credit channel” (Ralph Atkins: “ECB sets sights on shoring up banks”, Financial Times, December 5 2011).
________________

FINANCIAL CRISIS, FLIGHT-TO-QUALITY AND THE DOLLAR PROBLEM

AM | @MackinlayEuruni

. The Role of the Dollar as the key international reserve currency. Understanding the banking crisis: a (brief) look at the US dollar as the key international reserve currency. 1945-1973: Germany & Japan; 1978-2007: China. The stock of productive capital destroyed; authoritarian political culture. The solution: LOW COST OF LABOUR through a fixed (and undervalued) local currency against the dollar.

 . China’s economic development model. In order to avoid an exchange rate adjustment, China recycles its foreign-exchange reserves into the US credit market. [QUESTION: IMPACT ON THE US CREDIT MARKET??][CHART] [Annex to the Federal Reserve’s Weekly Balance Sheet]. Michael P. Dooley, David Folkerts-Landau & Peter Garber: “An Essay on the Revived Bretton Woods System”, NBER Working Paper 9971 (2003).

. Psychology & Markets: Attitudes toward risk. US credit markets flooded with cash! Jacques Rueff. Le péché monétaire de l’Occident. Paris: Plon, 1971:

The process works this way. When the U.S. has an unfavorable balance with another country (let us take as an example France), it settles up in dollars. The Frenchmen who receive these dollars sell them to the central bank, the Banque de France, taking their own national money, francs, in exchange. The Banque de France, in effect, creates these francs against the dollars. But then it turns around and invests the dollars back into the U.S. Thus the very same dollars expand the credit system of France, while still underpinning the credit system in the U.S. The country with a key currency is thus in the deceptively euphoric position of never having to pay off its international debts.

The money it pays to foreign creditors comes right back home, like a boomerang … The functioning of the international monetary system is thus reduced to a childish game in which, after each round, the winners return their marbles to the losers … The discovery of that secret [namely, that no adjustment takes place] has a profound impact on the psychology of nations (la psychologie des peuples) … This is the marvelous secret of the deficit without tears, which somehow gives some people the (false) impression that they can give without taking, lend without borrowing, and purchase without paying. This situation is the result of a collective error of historic proportions.
_______________________

FLIGHT-TO-SAFETY: SOME FOOD FOR THOUGHT

AM | @MackinlayEuruni

The F-t-S episode triggered by the collapse of Lehman Brother and by the European debt crisis has reached such proportions that more and more scholars, regulators and journalists are turning to the question from a variety of points of view. Here's a brief review of some of the most recent material.

. John Coates. The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust. Penguin, 2012 [info] [VIDEO]. See review by Clive Cookson: "The biology of banking", Financial Times, May 19-20, 2012.

. Paul Ormerod. Positive Linking. How Networks Can Revolutionise the World. Faber & Faber, 2012 [info]. See review by Claire Jones: "When copying others is the rational choice", Financial Times, July 9, 2012.

. Akerlof, George A. & Schiller, Robert A. Animal Spirits. How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism (Princeton University Press, 2009) [see]

. Turner Review. A regulatory response to the global banking crisis (London: Financial Services Authority, 2009). See p. 41: “Individual behaviour is not entirely rational. There are moreover insights from behavioural economics, cognitive psychology and neuroscience, which reveal that people often do not make decisions in the rational front of brain way assumed in neoclassical economics, but make decisions which are rooted in the instinctive part of the brain, and which at the collective level are bound to produce herd effects and thus irrational momentum swings”.

. J. M. Coates & J. Herbert: “Endogenous steroids and financial risk taking on a London trading floor”, Proceedings of the National Academy of Sciences, April 2008 [Judge Business School, University of Cambridge, Cambridge CB2 1AG, United Kingdom ; Cambridge Center for Brain Repair, University of Cambridge, Cambridge CB2 0PY, United Kingdom]. Edited by Bruce S. McEwen, The Rockefeller University, New York, NY, and approved November 6, 2007 (received for review May 1, 2007). Abstract: Little is known about the role of the endocrine system in financial risk taking. Here, we report the findings of a study in which we sampled, under real working conditions, endogenous steroids from a group of male traders in the City of London. We found that a trader's morning testosterone level predicts his day's profitability. We also found that a trader's cortisol rises with both the variance of his trading results and the volatility of the market. Our results suggest that higher testosterone may contribute to economic return, whereas cortisol is increased by risk. Our results point to a further possibility: testosterone and cortisol are known to have cognitive and behavioral effects, so if the acutely elevated steroids we observed were to persist or increase as volatility rises, they may shift risk preferences and even affect a trader's ability to engage in rational choice.

. Roger Boyes: "Age of Testosterone comes to end in Iceland", TimesOnline (February 7, 2009). Iceland, ravaged throughout history by volcanic eruptions and natural catastrophes, is struggling with a man-made disaster so overwhelming that the women are taking over. It is, they say here, the end of the Age of Testosterone. Next week a newly minted left-leaning Government led by Johanna Sigurdardottir will start to tackle the tough agenda of cleaning out the old-school-chum networks that have led Iceland to the verge of bankruptcy. Half of her Cabinet will be women; female advisers carrying briefcases move in and out of the Prime Minister's whitewashed office, a former jailhouse in the middle of Reykjavik. Two women, Birna Einarsdottir and Elin Sigfusdottir, now run the struggling and disgraced New Landsbanki and New Glitnir banks. We have to create a new sense of solidarity,” says the Social Democrat Prime Minister. The departing Government — retreating would be more precise — put business first, people second, say the premier's counsellors. Now is the time for a shift in values. Listening to Ms Sigurdardottir talk in her dry, schoolmistress manner, it becomes clear that the fall of the Icelandic Government was not just the first political casualty of the global downturn, but also a signal that men in suits have led the world astray. “We are going to base our economic policies on prudence and responsibility, but we also stress social values, women's rights, equality and justice,” she says. “You can see what is happening,” says Katrin Olafsdottir, Associate Professor of Economics and a member of the board of New Glitnir, which is trying to devise a new mission for the crippled bank. “The men went out there and took these incredibly irrational risks — and getting loads of money for doing it, feeling really good about it - and then the women have to come in to clean it up.”
_________________

UNDERSTANDING CREDIT MARKETS: FLIGHT-TO-SAFETY!

AM | @MackinlayEuruni

When Lehman Brothers declared bankruptcy on September 15 2008, one money-market fund that had lent as much as $785 million to Lehman declared that it was unable to pay the full amount of its liabilities. It was the first time that such an event took place! Investors promptly took $40 billion out of that fund. NOW EVERY PARTICIPANT IN THE CREDIT MARKET STARTS TO FEAR ABOUT THE SOLVENCY OF EVERYBODY ELSE!!! WHO HAS LENT TO LEHMAN? WHO HAS INSURED THOSE WHO HAVE LENT? ETC. ETC. ETC.

This feeling of general distrust sets in motion a flight-to-quality episode in credit markets. Let us see how that works. Imagine one Ms. De Souza, a 37-year old hospital manager in Sao Paulo, Brazil. A mother of two, she wants to send her children to a US college. She needs to very cautious about her $400.000 nest egg! She watches the Lehman news on TV; she reads the newspapers. She starts to worry. “What if my investments in loans to companies both in Brazil and the US decline in value as banks refuse to lend to private companies? What if my investments in loans to emerging market states decline in value as global economic trade and growth falls, forcing some states to default on their debt?” She makes up her mind and calls her broker in Sao Paulo, with three very precise instructions:

1. Stop all lending to entrepreneurs, wherever they are located

2. Stop all lending to sovereign issuers from emerging markets countries

3. Invest all the available resources into loans to the US Federal government, or to the German government.

The behavior of our hypothetical Ms. De Souza is replicated worldwide. Many investors react exactly like her: in Russia (INVESTING IN GERMAN BUNDS), in Thailand, in the Netherlands, etc. Now remember the paper from Horace Brock (Session 1): INTEREST RATES CHANGE WHENEVER NEW INFORMATION ALTERS THE BEHAVIOR OF EITHER/OR THOSE WHO SUPPLY LOANABLE RESOURCES AND THOSE WHO DEMAND CREDIT. The Lehman Brothers bankruptcy IS INDEED NEW INFORMATION! Interest rates are bound to change. But how? Let us look at two different kinds of credit markets: (a) sovereign borrowers; (b) corporate borrowers. 

(a) Sovereign borrowers (national governments). They can be further divided into two categories. Some countries that feature an institutional framework that protects the performance of contracts (rule of law, stable property rights, judicial independence). That list would include: US, UK, Canada, Germany, The Netherlands, Japan, most Nordic countries, Switzerland, etc. These tend to be perceived as risk-free borrowers.

(b) Corporations (companies). Unlike sovereign issuers, private companies are unable to impose taxes; their solvency is at risk whenever the economy goes into a prolonged recession.

Note that the definition of “risk-free” is not set in stone. The USA were very risky issuers of debt between 1776 and 1783! Nowadays, some emerging-market countries have made phenomenal progress in terms of property rights protection and credit market sophistication (Brazil, Singapore and South Korea come to mind here). BUT GENERALLY SPEAKING, FLIGHT-TO-QUALITY EPISODES TEND TO END UP WITH LOANABLE RESOURCES BEING REDIRECTED TO SOVEREIGN BONDS OF COUNTRIES WITH INDEPENDENT CENTRAL BANKS, JUDICIAL INDEPENDENCE, RULEOF LAW, ETC.

[DIAGRAMS. WE PLOT CHANGES IN THREE CREDIT MARKETS]

(a) AT EACH LEVEL OF THE INTEREST RATE, SUPPLIERS OF LOANABLE RESOURCES SUPPLY LESS IN THE ENTREPRENEURS CREDIT MARKET: THE INTEREST RATE GOES UP.

(b) AT EACH LEVEL OF THE INTEREST RATE, SUPPLIERS OF LOANABLE RESOURCES SUPPLY LESS IN THE CREDIT MARKET FOR RISKY SOVEREIGN BORROWERS: THE INTEREST RATE GOES UP.

(c) AT EACH LEVEL OF THE INTEREST RATE, SUPPLIERS OF LOANABLE RESOURCES SUPPLY MORE IN THE CREDIT MARKET FOR RISK-FREE SOVEREIGN BORROWERS: THE INTEREST RATE GOES DOWN.

A FLIGHT-TO-QUALITY EPISODE OCCURS WHENENVER EVENTS (a), (b) and (c) take place.
_____________

Credit spreads

Credit spreads are important financial and economic indicators. Credit spreads are simply the difference between two interest rates, one from a risk-free credit market and the other from a risky credit market.

(a) Credit spread between entrepreneurs’ and risk-free credit markets. Example. In the USA, the so-called “junk bonds” are credit contracts issued by entrepreneurs (see here). The risk-free credit market is the Treasury debt market – that is, debt issued by the US Federal government. If the interest rate for entrepreneurs is 6.70% and the interest rate for US Treasury debt is 1.86% (see), then the credit spread is 6.70% minus 1.86% = 4.84% [Note: these rates change every day, every hour, every minute!] 

(b) Credit spread between sovereign emerging market debtors and risk-free credit markets. Example. The average interest rate paid by risky sovereign issuers in emerging markets is currently 5.30% (see). The risk-free credit market is the Treasury debt market – that is, debt issued by the US Federal government. If the interest rate for risky sovereign emerging markets issuers is 5.30% and the interest rate for US Treasury debt is 1.86% (see), then the credit spread is 5.30% minus 1.86% = 3.44% [Note: these rates change every day, every hour, every minute!]

DURING A FLIGHT-TO-QUALITY EPISODE, CREDIT SPREADS TEND TO WIDEN, AS INTEREST RATES IN RISKY CREDIT MARKETS RISE, WHILE INTEREST RATES IN RISK-FREE CREDIT MARKETS DECREASES.

[CHARTS: JUNK BOND SPREADS]

NEGATIVE INTEREST RATES? ON DECEMBER 19, 2008, THE US 3-MONTH TREASURY BILL GOES NEGATIVE. WHAT DOES THAT MEAN?
_______________

BONDS

Bonds. Like any other type of investment vehicle, bonds provide investors with two kinds of income: (1) They provide current income, and (2) they can often used to generate varying amounts of capital gains. The current income is derived from the periodic receipt of interest payments. Capital gains, in contrast, are earned whenever market interest rates fall. 

VIDEO. The basics of bonds [see].

Pricing. A very basic rule in the market for fixed income securities is that interest rates and security prices move in opposite directions.

Key features. Type of issuer (governments, corporations), maturity, coupon and principal. 

Tenor / Maturity. In the US, 3-month to 1-year Treasury paper is called T-Bills; from 2 to 10 years, T-Notes; and T-bonds beyond that (30 years).

Balance sheet. Assets and liabilities! 

Size of the market. Government Bonds of US Commercial Banks, March 7 2012: $ 459.7 billion. Corporate Bonds. Corporate Bonds of US Commercial Banks, March 7 2012: $ 824.2 billion. Mortgage-Backed Securities. MBS of US Commercial Banks, March 7 2012: $ 1297.2 billion.

Case: UBS. From UBS's balance sheet [see, p. 43]. Exposure to French bonds: CHF 3525, of which CHF 2009 in corporate bonds, CHF 785 in sovereing bonds and CHF 730 in bank bonds. Bonds issued: CHF 158.
____________

CERTIFICATES OF DEPOSITS

Certificate of deposit. A certificate of deposit (CD) is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination.

CDs are generally issued by commercial banks and are insured by the FDIC (in the US). The term of a CD generally can range from one week to ten years. Retail certificates of deposit are defined as those under $100,000. Large time deposits are defined as deposits larger than $100,000.

Case. Sun Trust retail CDs [see].

Pricing. See Bankrate.com

Tenor / Maturity. 7 days to 10 years.

Balance sheet. Liabilities. Depositary sources of funds (non-depositary sources: bonds, borrowing from other banks, discount borrowing from the central bank).

Type of banking. Retail / corporate.

Size of the market. Retail deposits at US Commercial Banks, March 7 2012: $ 7.088.0 billion. Large time deposits at US Commercial Banks, March 7 2012: $ 1.499.0 billion. Source: US Federal Reserve.

See Adam Satariano: “Apple Seen Paying Some of $97.6 Billion in Cash as Dividend”, Bloomberg. Corporations are active players in the CD market!
_____________

SAVINGS ACCOUNTS

Savings accounts. A deposit account held at a bank or other financial institution that provides principal security and a modest interest. Savings accounts are generally for money that you don't intend to use for daily expenses. Because savings accounts almost always pay lower interest rates than Treasury bills and certificates of deposit, they should not be used for long-term holding periods. Their main advantages are liquidity and superior rates compared to checking accounts.

VIDEO. HSBC paying an extra-high interest rate: lool at the date! [see]

Pricing I. Short-term interest rates. See Bankrate.com

Pricing II. Maintenance fees: Sun Trust [see]. "Tiered interest rates": a pre-set scale of interest which is based on the premise that higher sums of money earn higher rates of interest.

Type of banking. Retail / Corporate.

Balance sheet. Liabilities. Depositary sources of funds (non-depositary sources: bonds, borrowing from other banks, discount borrowing from the central bank).
_____________

DEMAND DEPOSITS

Checking accounts. A transactional deposit account held at a financial institution that allows for withdrawals and deposits. Money held in a checking account is very liquid, and can be withdrawn using checks, automated cash machines and electronic debits, among other methods. A checking account differs from other bank accounts in that it often allows for numerous withdrawals and unlimited deposits, whereas savings accounts sometimes limit both. Checking accounts can include business accounts, student accounts and joint accounts along with many other types of accounts which offer similar features. In exchange for the liquidity, checking accounts typically do not offer a high interest rate. A checking account may also be called a "demand account" or "transactional account" [see].

Case. Excellent HSBC product description (retail) [see]. Note the attached product features.

VIDEO. Business Checking Account Comparison [see]; Citibank Mobile Check Deposit [see].

Pricing I. There may be some monthly maintenance fees in the case of large checking accounts [see].

Pricing II. There is a price to pay for overdraft protection! SunTrust [see]: "It’s not uncommon to occasionally get caught short of funds in your checking, savings, or money market account. When that happens, it’s helpful to have a backup plan to avoid bouncing a check or getting stranded at the ATM. Overdraft Protection: Sign up for this service and we’ll link your checking, savings, or money market account to your other SunTrust accounts and transfer the necessary funds to cover any shortfalls. As long as you have sufficient funds in your linked accounts, you’ll pay only a single $12.50 transfer fee on the day the overdraft occurs.

Balance sheet. Liabilities. Depositary sources of funds (non-depositary sources: bonds, borrowing from other banks, discount borrowing from the central bank).

Type of banking. Retail / Corporate.

Size of the market. Retail deposits at US Commercial Banks, March 7 2012: $ 1.872.3 billion.
_________________

TRADE FINANCE

Trade finance. See Deutsche Bank information on Flow Prodcuts and Structured Trade and Export Finance.

Balance sheet. Assets.

Type of banking. Corporate banking.
___________

COMMERCIAL & INDUSTRIAL LOANS

Commercial & industrial loans. Any type of loan made to a business or corporation and not to an individual. Commercial and industrial loans can be made in order to provide either working capital or to finance major capital expenditures. More info.

Case. Sun Trust lines of credit [see].

Balance sheet. Assets.

Type. In most cases a line of credit is secured by business assets, but an unsecured option may be available if certain credit conditions are met.

Maturity. Short-term (working capital); long-term (major capital expenditures)

Type of banking. Retail (small businesses lines of credit); Corporate (project financie, etc.)

Pricing. Variable interest rates (lines of credit: revolving credit, short term); Fixed interest rates (major financial capital expenditures: non-revolving credit, ling-term)..

Size of the market. Commercial & Industrial loans of US Commercial Banks, March 7 2012: $ 1379.3 billion.

Financial Times. "The UK offshore wind industry is heavily dependant on banks for project finance. This is not always easy in an inmature industry where the risks are often deemed complex and big. But now bank finance is not as easy as it was. 'Project finance is tight', says John Wood, a partner at the Norton Rose law firm. Traditionally, on project finance you would get a 15-yeaer repayment schedule for your debt. This has fallen to six or seven years, wich adds pressure when it is time to refinance. At the end of 2011, the UK had 636 turbines in 18 wind farms, accounting for more than 2 gigawatts of installed capacity -- the Saudi Arabia of offshore wind". Pilita Clark: "Financing woes pose a threat to 2020 target date", FT, June 4, 2012.
______________

CONSUMER LOANS

Consumer loans. Consumer loans are loans for purchasing automobiles and mobile homes, student loans, loans for medical expenses and vacations, and loans for other personal expenditures. They come in a variety of sizes and shapes. The following examples are all products offered by Sun Trust in the USA [see]. Equity loans: put your home’s equity to work for you with a range of home equity lending solutions. Auto Loans: explore the benefits of refinancing or get approved before you shop for a new or used vehicle). Physician Loans: cover a wide range of personal and business expenses with our physician loans. Personal Loans: obtain the funds you need with our affordable and flexible personal loans and lines of credit. Marine and Boat Loans: finance the purchase of a new or used boat or explore the benefits of refinancing. Education Loans: meet your college financing needs with private student loans.

See also Banco Santander (UK) Personal loans [see].

VIDEO. HSBC Personal loans [see; language unknown] (0:36); City Bank Texas home improvement loans (0.33) [see]; auto loans (0.32) [see].

Tenor. Medium to long-term.

Balance sheet. Assets.

Type. Unsecured (except auto loans, boat loans).

Pricing. Variable interest rates. See Bankrate.com

Type of banking. Retail.

Size of the market. March 7 2012: $ 1093.4 billion in the US.

______________

BANKS: SIX GERMAN BANKS SUFFER RATING CUTS

Six German banks have had their credit ratings downgraded because of the risk of further shocks from the eurozone debt crisis. Moody's, the rating agency, cut ratings for Commerzbank, Germany's second-largest bank by assets, and five other banks in the eurozone's largest economy. Moody's also downgraded Austria's three largest banks, all with heavy exposure to economies in central and eastern Europe. The downgrades were less severe than those suffered by other European banks; the German economy has held up well in the crisis, driving down unemployment and reducing the risk to banks of loan default by private and corporate customers. [From James Wilson: "Six German banks suffer rating cuts", Financial Times, 7 June 2012]
______________

http://www.us.hsbc.com/1/2/home/premier/banking

Basel II capital requirements

Remember the formula to rank loans in terms of the capital required:

Capital required = (size of the loan) x (risk weight) x 8%

Bank & Treasury Management - BSF222

Agustin Mackinlay 

a.mackinlay@euruni.edu

Session 10 - April 17, 2012

________________

. A look at Financial Markets

. Assets, Liabilities, Return on Equity

. A Word on Investment Banking

. The weak March Jobs Report (CNBC)

. Chinese Gross Domestic Product (CNBC VIDEO)

. The Situation in Spain (CNBC VIDEO with some charts).

 VIDEO: Investment Banks
Investment banking: Bloomberg table on Fixed Income

• Investment banking: Morgan Stanley quarterly results
• Maureen Farell: “Facebook IPO: Morgan Stanley is Big Winner”, CNNMoney.

From Maureen Farell: “As the lead underwriter, Morgan Stanley is likely to receive the lion's share of fees from the offering. The company is preparing to raise $5 billion in its initial public offering, which would the biggest Internet IPO ever. Facebook will be valued at as much as $100 billion in the stock sale, people familiar with the matter have said. And that's just the start. It positions Morgan Stanley for lead roles in future Facebook debt offerings or acquisitions” (*).

 (*) Facebook buys Instagram for $1bn (see). 

Gupta insider trading case

Bank & Treasury Management - BSF222
Agustin Mackinlay

a.mackinlay@euruni.edu

Session 9 - March 27, 2012

_________________________________

From balance sheet to income statement****: VIDEO

Interest rates, the economy and banks: CNBC VIDEO

Remarks by (former) Fed Chairman Alan Greenspan (April 5, 2000) [see]

As our experience over the past century and more attests, such surges in prospective investment profitability carry with them consequences for interest rates, which ultimately are part of the process that balances saving and investment in a noninflationary economy. In these circumstances, rising credit demand is almost always reflected in an increase in corporate borrowing costs and that has, indeed, been our recent experience, especially in longer-dated debt issues. Real interest rates on corporate bonds have risen more than a percentage point in the past couple of years. Home mortgage rates have risen comparably. The Federal Reserve has responded in a similar manner, by gradually raising the federal funds rate over the past year. Certainly, to have done otherwise--to have held the federal funds rate at last year's level even as credit demands and market interest rates rose--would have required an inappropriately inflationary expansion of liquidity. It is difficult to imagine product price levels remaining tame over the longer haul had there been such an expansion of liquidity.

Testimony of Chairman Alan Greenspan, July 18, 2001 [see]

The shortfall of saving to finance investment showed through in a significant rise in average real long-term corporate interest rates starting in early 1999. By June of that year, it was evident to the Federal Open Market Committee that to continue to hold the funds rate at the then-prevailing level of 4-3/4 percent in the face of rising real long-term corporate rates would have required a major infusion of liquidity

Bank & Treasury Management - BSF222

Agustin Mackinlay 

a.mackinlay@euruni.edu

Session 8 - March 20, 2012

A REVIEW OF THE EXAM

_________________________________

·      Assets & Liabilities

·      The Yield Curve
·      LIBOR futures

[1] A BANK IS A BUSINESS!

Banking is a business; as such, its aim is to make a profit. How? By making LOANS for which it charges an interest rate.  LOANS => INTEREST RATE = > PROFIT

[2] WHERE DOES THE MONEY COME FROM?

The money that is lent out at interest comes (mostly) from the capital of the owners and from DEPOSITS.

Assets                                                BANK                   Liabilities & Equity                      

LOANS	DEPOSITS
	EQUITY

[3] NET INTEREST MARGIN

Net interest margin, also sometimes referred to as the net yield on interest-earning assets, is usually defined as net interest income, divided by interest-earning assets. The margin is calculated for a period of time, a quarter or a year, and is expressed as a percentage.

NIM = NET INTEREST INCOME  /  INTEREST-EARNING ASSETS

Where:

NET INTEREST INCOME = INTEREST EARNED ON ASSET  LESS INTEREST PAID ON DEPOSITS (AND OTHER SOURCES OF FUNDING)

[4] TYPES OF LOANS

. US Federal Reserve: Assets and Liabilities of Commercial Banks in the United States (Weekly) - H.8

. US Federal Reserve: Senior Loan Officer Opinion Survey on Bank Lending Practices

. January Senior Loan Officer Opinion Survey on Bank Lending Practices

(a) Real Estate loans.   

Residential real estate loans. A mortgage loan is a loan secured by real property. A home buyer can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, can vary considerably.

[Residential real estate loans of US Commercial Banks, March 7 2012: $ 2114.5 billion]

Commercial real estate loans are available on all types of income producing and commercial properties, including: Shopping centers; Motels and apartments; Office buildings; Automobile dealerships; Health care facilities; Manufacturing facilities and more. Commercial real estate loans can also be used to refinance existing debt. There are typically two main types of loans including short term and long term. The short term loans consist of bridge loans that are used to keep the business running until larger and more long term loans can be obtained. The larger loans are for larger amounts and typically last for the life of the commercial real estate property. Commercial real estate loans are important for the growth and expansion of companies.

[Commercial real estate loans of US Commercial Banks, March7 2012: $ 1424.4 billion]

(b) Commercial and Industrial loans.

Any type of loan made to a business or corporation and not to an individual. Commercial and industrial loans can be made in order to provide either working capital [SHORT-TERM] or to finance major capital expenditures [LONG-TERM]. More info.

[Commercial & Industrial loans of US Commercial Banks, March 7 2012: $ 1379.3 billion]

(c) Consumer loans.

Loans for purchasing automobiles and mobile homes, student loans, loans for medical expenses and vacations, and loans for other personal expenditures [MEDIUM TO LONG-TERM].

[Consumer loans of US Commercial Banks, March 7 2012: $ 1093.4 billion]

[EXERCISE: LOOK AT THE FOLLOWING TYPES OF LOANS; IN EACH CASE, IDENTIFY WHETHER THEY ARE COMMERCIAL & INDUSTRIAL, PERSONAL, OR REAL ESTATE LOANS]

Example 1. Trade Receivables Finance from Deutsche Bank
Trade Receivables are generated from the sale of goods or services to another company [goods are sold against payment in 30, 60, 90, 180 days]. Trade Receivables Finance enables a company to finance against these trade receivables in order to increase day-to-day cash-flow, improve its ability to fulfill further orders and meet the daily operating costs of the business.

Example 2. Small Business loans from Bank from Sun Trust.

Sometimes all it takes to boost a small business is a business loan. SunTrust’s business loans and lines of credit offer that extra lift. Our small business loans offer competitive rates and flexible terms to help cover most of your financing needs, whether you want to build a new facility, furnish your existing space or stockpile inventory before your busiest time of year.

Example 3. Consumer Loans from Sun Trust

Equity Loans and Lines of Credit (Put your home’s equity to work for you with a range of home equity lending solutions); Auto Loans (Explore the benefits of refinancing or get approved before you shop for a new or used vehicle); Physician Loans (Cover a wide range of personal and business expenses with our physician loans); Personal Loans and Lines of Credit (Obtain the funds you need with our affordable and flexible personal loans and lines of credit); Marine and Boat Loans (Finance the purchase of a new or used boat or explore the benefits of refinancing); Motorhome and RV Loans (Select from a full range of motorhome and RV loans to fit your borrowing needs); Education Loans (Meet your college financing needs with private student loans from SunTrust.).

Example 4. A Syndicated Loan to VTB Bank Austria arranged by Deutsche Bank

$280mn Syndicated Term Loan Facility for VTB Bank (Austria) AG (formerly Donau-Bank AG) arranged by Deutsche Bank signs over subscribed and increased . Mandated Lead Arranger, Deutsche Bank AG London today announced the signing in Vienna of the US$280mn, the largest syndicated loan for VTBA to date. The following banks joined the Facility as Mandated Lead Arrangers in syndication: Agricultural Bank of China, Singapore Branch, AKA Ausfuhrkredit-Gesellschaft mbH, BAWAG P.S.K. Bank fuer Arbeit und Wirtschaft und Österreichische Postsparkasse Aktiengesellschaft, BayernLB, Erste Bank, KBC Bank NV Dublin Branch, HSH Nordbank AG Luxembourg Branch, Mizuho Corporate Bank, Ltd., Norddeutsche Landesbank Luxembourg S.A. A total of 15 other banks joined during the general syndication phase.

Example 5. CitiMortgage [see]. See interest rates at the bottom of the page!

 

[5] OTHER ASSETS

. US Federal Reserve: Assets and Liabilities of Commercial Banks in the United States (Weekly) - H.8

. US Federal Reserve: Senior Loan Officer Opinion Survey on Bank Lending Practices

(a) Government Bonds.  

[Government Bonds of US Commercial Banks, March 7 2012: $ 459.7 billion]

(b) Corporate Bonds.  

[Corporate Bonds of US Commercial Banks, March 7 2012: $ 824.2 billion]

(c) Mortgage-Backed Securities.  

[MBS of US Commercial Banks, March 7 2012: $ 1297.2 billion]

(d) Overnight-loans to other banks.  

[Residential real estate loans of US Commercial Banks, March 7 2012: $ 981.7 billion]

(e) Cash. Includes vault cash, cash items in process of collection, balances due from depository institutions, and reserves at the Federal Reserve.

[Cash balances of US Commercial Banks, March 7 2012: $ 1609.0 billion]

Example 1. VTB, Erste Bank.

VTB: “Financial assets”: 654.1 billions of Russian roubles [see].

Erste Bank: “Financial assets”: €38.4  billion [see].

[6] LIABILITIES: BANK DEPOSITS

[Retail deposits at US Commercial Banks, March 7 2012: $ 7.088.0 billion]

[Large time deposits at US Commercial Banks, March 7 2012: $ 1.499.0 billion]

Example. Retail Deposit accounts at SunTrust [see]

. Checking accounts with online banking + mobile banking.

. Student checking accounts.

. Savings accounts.

. Certificates of deposit. Retail certificates of deposit (CDs) are defined as those under $100,000. “Our CDs pay competitive guaranteed fixed interest rates with maturities ranging from 7 days to 10 years. You can open a CD with a minimum deposit of $2,000. The more you save, the more you’ll earn”.

 
Large time deposits are defined as deposits larger than $100,000. Corporations are active players. Example: Apple has almost $98 billion in cash! See Adam Satariano: “Apple Seen Paying Some of $97.6 Billion in Cash as Dividend”, Bloomberg.

[7] LIABILITIES: BORROWING FROM BANKS

[Retail deposits at US Commercial Banks, March 7 2012: $ 1.872.3 billion]

Very short term!

[8] BONDS ISSUED BY BANKS

[Bonds issued by US Commercial Banks, March 7 2012: $ 779.0 billion]

[EXERCISE: LOOK AT LIABILITIES OF DIFFERENT SORTS]

Liabilities @ Erste Bank (www.erstebank.com)

. Deposits by corporations: €21.7  billion [see].

. Customer deposits: €121.6  billion [see].

. Debt securities in issue: €34.6  billion [see].

Web page devoted to debt investors [see]. The growing international activity of Erste Bank led it to develop alternative sources to the classic primary funding through customer deposits. The bank employs a wide range of funding sources and programmes to meet the funding requirements of the Group, its subsidiaries and the Austrian savings banks. The bank is active in Austria and internationally as a private placement issuer as well as making public issues in varying currencies, maturities and structures. Senior bonds are the biggest segment. They made more than a half of total outstanding debts. (Definition of senior bonds: In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds).

[QUESTION: WHY WOULD A BANK DEVOTE A WEBPAGE TO INFORM ON ITS DEBT?]

[8] ASSETS & LIABILITIES: EXAMPLES

. Swedbank balance sheet (p.12):

____________