Transcript Advanced Risk Issues: Managing Derivative Risk

Advanced Risk Issues
Summary and Observations
Dallas, Texas
October, 2007
Advanced Risk Issues
Risk Management and
Revenue Growth in a
Complex Global Bank
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Advanced Risk Issues
Why Were We Here?
● What are the risk issues that are of prime
concern to Citi today?
● How is Citi managing risk today?
● How do risk management and business
management work together to drive
shareholder value?
● To help remind you what you already know
about risk management and analysis!
● And, to remind you that great bankers are
skeptical by nature
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Lessons Learned…….
Why do smart bankers sometimes do bad
deals?
Mistakes about the use of Citi’s capital – risk / reward
Missing the most important risk decision - Choose clients
very carefully
Lack of understanding of industry dynamics and risks
Lack of understanding of client’s motivation for doing a deal
Pressure to generate revenue
Going along with the “herd”
Ignoring the credit risk component of all risk products
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Moody’s 2005 Securities Industry Outlook
“For all global trading and market-making firms, highlyskilled risk management - broadly defined - is an absolute
necessity for the business model.
“A robust corporate culture remains critical for balancing
short-term competitive pressures and the long-term
interests of a franchise.
In a hotly competitive arena, fraught with litigation and
regulatory risk, an investment bank needs a collective
sense of right and wrong.
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Moody's Investors Service upgrades the ratings of Citibank N.A. to
Aaa for long-term deposits and to A for financial strength
September 26, 2006
The firm has made progress on strengthening
culture and improving controls, and has not suffered
a major control problem since having to close its
Japanese private bank.
However , management must continue to solidify
cultural change, notwithstanding shareholder
pressure for earnings growth
Moody's assessed the effectiveness of risk controls,
measurement and information infrastructure as well
as the firm's risk governance and culture.
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“Credit Matters Today”
March 5, 2007
Strong earnings generation from an extraordinarily
diverse set of businesses allows Citigroup Inc.
(Citi; AA/Stable/A-1+) to cover some of the high
risks that it incurs.
Citi has also achieved a substantial change in its
control environment in the aftermath of a wave of
heavy litigation expenses and criticism of its
business practices from regulators around the
world.
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Survey of International Banking – May, 2006
Banks the world over are scrambling to become larger…
But at some point diseconomies of scale will also start
creeping in, with management finding it harder to
summarize everything that is going on in the bank
This includes the neglect of concealed risks and the failure
of internal controls
This problem afflicted Citigroup in 2002 – 2005 when it was
rocked by a string of compliance problems
Risk management is the rock on which any contemporary
bank rests….
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The alchemists of finance –
May, 2007
Global investment banks are taking ever
more risk, and are devising ever more
sophisticated ways of spreading it
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Credit Risk Supervision – Sabeth Siddique
May, 2007
It is “unsafe and unsound” to be in credit risk trading
without an understanding of the risks being traded
Banks should not be trading credit risk on “technical
factors”
There is a large, new risk – “Pipeline” Risk. The risk
that a market event will dry up liquidity in the middle of
a syndication or creation of credit default protection
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Banks in trouble
The game is up
Aug 16th 2007
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Headlines
September 20, 2007
Regulators rethink bank rules
The treasurer of one big investment bank admits: "What we are seeing now is
like a natural disaster - whole parts of the financial system which we took for
granted have stopped working. But that was not something that people had
really prepared for."
Until now regulators have generally tolerated - if not actively encouraged - this
"originate and distribute" trend, since there was a widespread belief that the
financial system would be safer if credit risk were spread around.
However, this summer's events have shattered some of these comforting
assumptions.
Although banks have shoved risk out through the "front door" (as evidenced in
their published accounts), they have been re-acquiring it in other, indirect - or
backdoor - ways.
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Good Risk Management is a Driver of Revenue Growth
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Advanced Risk Issues
Monday Sept 17 – Participants’ Risk Concerns
Managing opportunities to grow
market share
Recruiting and staffing – challenge
to attract “A” players
Lack of investment in technology
to monitor risk
Process is an impediment to
business growth – timeliness of
decision making and MIS
Execution risk
Market segmentation vs skills of
the bankers
Process flow from origination to
closing
Market perception and “herd”
mentality
Systems – time consuming manual
fixes
Reputation risk relative to client
and staff acquisition
Adverse selection in growth of
business
Execution risk
Systems and operational risk
Process
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Advanced Risk Issues
Course Overview
Basic Credit Risk Analysis
• Industry Structure and Company Risk Analysis
– Balancing Business Risk and Financial Risk (Key
Success Factor Exercise)
– Identifying Winners and Losers.
– Framework for a common sense approach to make
independent relative risk ratings
• Early Warning Signs / Problem Recognition
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Advanced Risk Issues
Course Overview
Assessing management ability, business strategy,
and controls
• Management Competence and Business
Strategy (Corning Case)
• Business Controls (Citibank Dublin Case)
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Advanced Risk Issues
Course Overview
Deal Structure and Risk
- Poland A2 Motorway Case
Converging Risk Issues – Credit Risk, Market Risk,
Derivatives Risk
How Does Citi manage risk?
• Underwriting risk and conflict management
• Market risk / Convergence Risk
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ARI Presentations – “Seeing Around Corners”
CBG Risk Management – Nancy Shanik, John Gilliland
Citi / CBG Management – Jorge Bermudez
Conflict Management / Franchise Risk – Rashmini Yogaratnam
Market Risk / Convergence Risk – Murray Barnes
Problem Recognition / Early Warning Signs - John Dowd
Company and Industry Analysis – Arnie Ziegel
Derivatives Risk – Patrick Pancoast
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Advanced Risk Issues
Quotes of the Week
• People act in their own economic interests
– Nancy Shanik
• There’s no amount of revenue that can make up for a bad loan
– Jorge Bermudez, Bob Druskin
• Deregulation is a horrible thing for a creditor
– John Dowd
• What’s the value of credit analysis or credit analysts if the
market tells us what the risk is?
– Patrick Pancoast
• I bought this, but you shouldn’t have sold it to me
– Rashmini Yogaratnam
• Your initial is your initial, my initial is my initial
– Jorge Bermudez
• Who’s fault is it? It’s yours – you gave me the money, you let
me do the trade, you told me to invest
– Arnie Ziegel
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Advanced Risk Issues
Quotes of the Week
•
In the long run, treating customers fairly has proven to be good
business
–
•
Rashmini Yogaratnam
When liquidity conditions deteriorate, market risk becomes credit risk
and, when liquidity completely disappears, all risks converge
–
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Murray Barnes
It was easier to get approved because it was harder to understand
–
•
Patrick Pancoast
My best risk manager is a well balanced risk manager
–
Jorge Bermudez
• Management's tolerance for loss is not the same as tolerance for risk
– Murray Barnes
•
Don’t mix high business risk with high financial risk
–
Arnie Ziegel
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Advanced Risk Issues
Quotes of the Week
•Companies go bankrupt because they 1) run out of cash, 2) fear
that they’ll run out of cash, or 3) their suppliers of liquidity fear that
they’ll run out of cash
– Arnie Ziegel
• The unknown unknowns, known unknowns
– Murray Barnes
• Many business problems or losses are the result of flawed
business strategies
– Arnie Ziegel
• Funding long-term, illiquid assets with short-term money is a
high risk strategy, irrespective of the credit quality of the assets
– Murray Barnes
• If you can’t mark to market, you mark to model. If you can’t
market to model, you mark to guess. And we guess very
professionally
– Patrick Pancoast
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Advanced Risk Issues
Quotes of the Week
•
Choose your clients carefully
– Arnie Ziegel
•
Why is it that we do not ask as many questions when we
make money as when we lose money?
– Murray Barnes
• Trust and verify
– Jorge Bermudez, Dave Bushnell
• Affirmative risk taking is awareness of the risks you’re taking –
with your eyes wide open!
– Nancy Shanik
•
I would rather get fired for not making my revenue target than
making it for two years and then have my portfolio blow up!
– Jorge Bermudez
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Why Were We Here?
●Excellent risk management creates shareholder value
and can be a major driver of high quality revenue
growth
●Taking risk is one thing, managing risk is another
●Excellent risk management for revenue growth
requires:
“Seeing around corners” - finding risk where we didn’t
know or think it existed, and the convergence of types of
risks, along with the associated opportunities
Skepticism to balance risk with the need to generate
revenue growth
Identifying potential flaws of business strategies – internal
and clients
Understanding the increasing complexity of products
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Why Were We Here?
Excellent risk management for revenue growth
requires:
● Understanding the reputation and franchise
implications of business decisions – each decision
often impacts multiple constituents – issuers and
investors, regulators, shareholders
● Understanding that we will never see all risks, so we
– Don’t assume that what we distribute, or plan to distribute,
can’t come back
– Structure away from risk
– Choose clients carefully
– Pursue active portfolio management
– Create and maintain a superb control culture and business
culture
– Create and maintain systems for monitoring risk
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Why Were We Here?
To recognize that risk, product, and coverage can generate the
most shareholder value by working together
To review what risks Citi is taking or facing, and how Citi is
managing risk
Growth demands MORE risk and MORE reward, and it’s up to you
to get the balance right
We can grow and still “stick to the fundamentals”
Credit risk analysis is truly at the heart of all risk analysis
To remind you that excellent bankers don’t hesitate to say “I’m
sorry, but I just don’t understand….”
To recognize that Citi is held to a higher standard, not just because
Citi is big, but because Citi is the leader……………
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Advanced Risk Issues 2007
Seeing Around Corners
Risk Management and
Revenue Growth
in a
Complex Global Bank
www.mountainmentorsassociates.com
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