Portfolio Management - an

emerging strategy for

excellence
A Banks Perspective

Executive Summary

Concept of Portfolio Management an

emerging strategy for excellence
Portfolio Management reporting /
monitoring function OR profit center

Origination versus ownership of risk

Key transfer pricing challenges

Maximizing shareholder value

Key challenges

Traditional Model

Buy

Hold

Philosophy of holding assets till maturity (or

default)
Relationships have been perceived by the
extent of paper / risk that is held by banks
Performance metrics have been driven by
revenues & net income versus economic capital
and ROE
Emphasis on primary distribution with no
markets / products for secondary sales

Strategic Rationale for Change

The take and hold proprietary portfolio has been a

dumping ground for product groups, resulting in
assets that have been low yielding, illiquid, sub par
and large users of capital
Portfolio diversity. Lack of a Portfolio approach
resulted in imbalances that have been difficult to
manage i.e. in cyclical industries, weaker countries
etc.
Lack of accountability - the balance sheet
subsidized all businesses
Low ROC for Credit Business driving the need for
creating Velocity.

Strategic Rationale for Change

Emergence of a secondary market. Flight to quality

led to a smaller domain of issuers.
Growing shift in portfolio metrics to ROE and SVA.
Usage of economic capital and specific return on
residual assets gaining importance.
The new paradigm for return on capital

Net Income
Revenue

Margin

Revenue
Capital

Velocity

Return on
Capital

Concept of Portfolio Management

Portfolio Management discipline is this
an emerging strategy for excellence ? YES

Advocate of shareholder value

Scope is not just limited to credit risk

management, but more

Owners of risk and capital

Fund managers with discretion over the proprietary risk portfolio

Investor driven approach. Hold positions benchmarked to market

standards.

Portfolio Management is viewed as an integral

link between Issuers and Investors to ensure that
the bank is not stuffed with substandard assets

The New Structure

B
o
r
r
o
w
e
r
s

Client
Manage
ment

Portfolio
Manager
Credit decision
Risk Rating

Origination

Syndication

Loan
Trading

Pricing/Return
Portfolio Decision

Servicing

Hedging &
Securitizati
on

S
e
c
o
n
d
a
r
y
M
k
t

N ew Approach to Portfolio Management

Buy

Sell, Hedge

Originate to distribute
Portfolio Management acts as buyer, seller and
manager of risk
Support OR profit center ?
Support in a cross sell environment
Hold to be at least SVA neutral

Fundamental shift in viewing exposures from

Approved commitments to Economic capital
usage

Origination versus Ownership of risk

Portfolio managers are owners of risk and CAPITAL

Given scarcity of capital and unattractive loan

products in most markets, pure origination of loan
products with no cross sell makes little economic
sense

Close linkages however exist (especially in loan

products) where a residual piece sits in the portfolio.
Quality of origination hinges on the risk appetite of
the Portfolio Manager

Origination would be limited to Portfolio balancing to

ensure appropriate weight age achieved through
credit swaps, CDOs, secondary markets etc.

Most CIB platforms today are evolving & do not have

NIR as an independent financial target.

Portfolio Management Philosophy

Improve credit / risk and product

delivery processes to transform the
traditional lending business into an
issuer and investor-driven, mark-tomarket-based, Originate to Distribute
business.

Portfolio Management : Role

Strategy
DCM

Derivatives

Other products

Portfolio Management Process

Origination
Process

ISSUER

INVESTOR

Structuring Process
Market Clearing Process

Distribution
Process

The New Structure - Advantages

Leads to increased transparency and reduces

cross subsidization
Balances issuers and investors the universal debt
model has traditionally been based on what
Issuers need (and not what Investors want)
Leads to sharper risk-return discipline while
putting the b/s on line
Benchmarks the portfolio to market especially for
loan products
Focused on Distribution that will reduce Credit
Capital and hence increases ROE

Key Attributes
Strategic Risk Capital Allocation

Strategy Process

Risk capital to be BID for by Global

Industry and Key Product groups
Creation of a common platform where
all product partners will project their
business and expected ROE. Risk
capital will be allocated on this basis
All clients will be assigned peak risk
capital and ROE targets
Portfolio Risk Management will be a
key part of this process to set risk
appetite
Robust return measurement metrics
will drive on-going capital allocation

Key Attributes
Active Portfolio Risk Management
Portfolio Risk Management Process

Credit will be a parallel process, no longer a sequential

process
Portfolios will be run on a GLOBAL basis in line with the
type of exposure
The originate to distribute process will lead to greater
discussion on the ultimate hold levels
Risk capital usage will be actively managed by Portfolio
Management, which will be judged by return on
economic capital deployed
Credit risk decisions (buying, selling and hedging) will
be made within Portfolio Risk Management.

Key Transfer pricing challenges

Portfolio Management is the advocate of

shareholder value. Approval / renewal of all
exposure is contingent on the return, irrespective
of where revenues are booked or recognized.
Key challenge is to be able price loan products
appropriately while ensuring an acceptable
return on the entire credit exposure
Loans should be priced to be at least SVA or
Economic profit neutral
Loan structure and pricing should be reflective of
the prevailing investor market to provide liquidity
to the loan portfolios

Maximizing Shareholder Value - SVA

Why a new metric?

Driven by the growth strategy and the

increasing focus on shareholder value
creation

What is Shareholder Value-Added (SVA)?

SVA is a measure of firms profit after

subtracting the cost of all capital employed.
It is defined as the current period after-tax
economic earnings less a charge for the use
of capital.*
Simply put, it is the portion of the dollar
return generated by the business that is in
excess of the dollars paid for the use of
capital to support the business

Maximizing Shareholder Value - SVA

SVA Drivers

Capital usage

Pricing discipline

Volume / pricing management

Mix of revenue

Credit quality

Maximizing Shareholder Value

The economic capital

framework creates a
common currency for
measuring risks and returns
Different forms of risk:
Credit, Market, Country and
Business risks are quantified
on a uniform scale
Performance is expressed as
an after-tax return on
economic capital
The framework creates
incentives to deploy capital
toward activities with better
risk adjusted returns

Measuring return relative to

risk
Firm Value

Investors Required Return

Return

Expected
Cashflow

Risk

Growth of
Investment
Base

Key Challenges to implement this

Approach in our Markets

Lack of liquidity (both depth and breath) in

the secondary loan trading markets
Most profitability models are global and
need to be customized for regional /
emerging markets
Not enough volume to sustain an active
model in the current environment
tendency is to hang onto good quality
assets

Key Challenges to implement this

Approach in our Markets

Potential negative impact on client

relationships. Need to align all product
specialists to a common goal vis a vis
clients to avoid different agendas
Teamwork is critical for success. Creates
another silo in an already over matrix
environment
Severe compression in spreads which makes
the ultimate hold position uneconomical
and the portfolio manager lukewarm to the
transaction