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Banc One Corporation Asset and Liability Management Case Solution

Solution Id Length Case Author Case Publisher
2499 1818 Words (7 Pages) Peter Tufano, Benjamin C. Esty Harvard Business School : 294079
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Banc One Corporation, is the eighth-largest bank holding company in the United States, with $76.5 billion in assets. In the 1980s, Banc One became aware of the dangers of interest rate risk. For risk management, a variety of interest rate swaps were used. If you're interested in an interest rate swap, you'll need to agree on how many times you'll be exchanging loans with the other party. While the interest rate on one side changes, the underlying idea does not. An interstate from the other side is yours! Those in charge of the organisation believe this is an effective risk management strategy. However, some analysts believe that Bank One's rapidly expanding swap position may overestimate the company's profitability while concealing the decline in other areas. Investors are concerned about the use of interest rate swaps because they are difficult to comprehend. Banc One's stock price has dropped by $10 as a consequence, and numerous analysts have cut their stock ratings.

Following questions are answered in this case study solution

  1. If Banc One Corp. wanted to manage its interest rate exposure without using swaps, what could it do? Specifically, how could it move from being asset-sensitive to either neutral or mildly liability-sensitive without using swaps? What are the pros and cons of using swaps v. these other means of adjusting the bank’s interest rate sensitivity? What impact do they have on the bank’s interest-rate sensitivity, liquidity, accounting ratios, and capital ratios?

  2. What are AIRS? How do they work? Why is Banc One using them so extensively?

  3. What are basis swaps? Why has Banc One recently significantly increased its basis swap position?

  4. How might its derivatives portfolio be damaging the bank’s stock price? What exactly are analysts and investors worried about?

  5. Recommendation: What should McCoy do?

Case Analysis for Banc One Corporation Asset and Liability Management Case Solution

1. If Banc One Corp. wanted to manage its interest rate exposure without using swaps, what could it do? Specifically, how could it move from being asset-sensitive to either neutral or mildly liability-sensitive without using swaps? What are the pros and cons of using swaps v. these other means of adjusting the bank’s interest rate sensitivity? What impact do they have on the bank’s interest-rate sensitivity, liquidity, accounting ratios, and capital ratios?

1. In the absence of swap contracts, Banc One might manage its interest rate risk by investing in one of the many other investment options accessible. The following are other avenues for investment: To meet Banc One's needs, they should choose an Interest Rate Management Option.

2. If interest rates rise, Banc One (the holder) has the opportunity to earn from it, which means that Banc One has the capacity to profit from both scenarios. In the area of floating-rate loans, where Banc One is operating, this financial derivative might be quite useful in protecting those who take out these loans. Because of this choice, Banc One may move from being asset-sensitive to neutral or just a little bit liability-sensitive without having to employ swap contracts.

3. Pros

  • Swaps are a kind of off-balance-sheet asset. The only place in the financial statements where they are referenced is in the footnotes. Swap-related gains and losses nevertheless appear on an income statement, leading to an overestimation of the company's profitability.

  • Investing less money in compliance with the agency's criteria is a benefit to businesses. There is no extra to pay up ahead for swaps. Can boost the liquidity of Banc One's assets.

  • Maintaining liquidity while taking advantage of long-term asset benefits (yield curve) is possible.

Cons

  • Swap contracts' market is currently not particularly liquid.

  • Swaps may fail to meet their financial commitments.

  • When the economy is in turmoil, swaps are not a feasible investment option.

4. Swaps, on the other hand, might have a negative impact on the bank's liquidity since they aren't very liquid. As a result, interest rate fluctuations are less sensitive to changes in swaps. The profitability ratios of banks benefit from swaps, it is true. Because of their negative impact on corporate capital ratios, swap transactions are not recommended.

2. What are AIRS? How do they work? Why is Banc One using them so extensively?

AIRS stands for amortised interest rate swaps. It was the work of Banc One and its associates that resulted in this breakthrough. AIRS also made mortgage-backed securities investments. When interest rates are low, borrowers are more likely to pay off their mortgages early, putting lenders at danger of default. AIRS may be used to amortise the swap's notional value if interest rates decline. When interest rates were lower, the AIRS would be amortised more quickly. In times of poor returns, this would allow the bank to reinvest. If rates rise, however, an AIRS' maturity period will be longer than expected. As a result, the bank would get a lower-than-average return on its investment.

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