Banc One Corporation Asset And Liability Management Case Study Solution
AIRS and Banc Usage
Amortizing Interest Rate Swaps (AIRS) in the Banc Corporation are propagated with the need to develop artificial collateralized mortgage obligation (CMO) which are parallel to the swaps. CMO investments required some other obligations related to returns along with the characteristics of swaps. CMO’s allows the investors to invest in different mortgage activities in order to get more benefits. CMO’s are also organized accordingly and can be easily estimated by the investors related to the frequent installments. One of the major advantage of AIRS is that, it can provide higher benefit in low interest rate environments by amortizing quickly than other methods(MITCHELL, 2019).
Basis Swaps and its Usage
Basis swaps are the swaps that are used to change the prime based floating rate assets into the fixed income based assets. Although the synthetic investment is partially shielded with the bank, the Banc Corporation is still susceptible to basis risk to form the sensitivity of future interest rates changes. It is observed that the LIBOR and Prime rates are changed frequently as these are the daily trading rates and governed by bankers.
Bank’s Stock Price and Investor’s Concern
The major problem faced by Banc One Corporation is a fall in its share price in the year 1993. In April 1993, the share price of Banc One Corporation was 48 dollars which declined to 36 dollars in November 1993 which shows a share price decline of around 25 percent in just 8 months. This decline had badly impacted on the upcoming several acquisitions that include the acquisition of Liberty National Bancorp.
The investors have highly concerned about the transparency and accuracy of the financial statements of a bank which should be reflected in the market. One of the major concern behind the negative attitude of shareholders regarding the interest rate swaps, even after being an optimal tool of managing risk, is the off-balance sheet nature of swaps that might underestimate the bank assets and overestimate the performance of its net earnings (such as true ROA, E/A ratio and net interest margin reflection).
Recommendations
McCoy should educate the investors about the usage of swaps and other derivative instruments that if the Banc One Corporation will limit its trading through derivatives such as swaps, forward and future contracts, the interest rate exposure risk will be increased for the bank as well for investors. The Banc One’s current strategy is an optimal strategy which provides a higher return with minimal risk to the bank and its investors. The only thing that needs to be done is to educate the investors related to the investment in derivatives.
Calculations related to this case are attached in Appendix 1
Appendices
Appendix-1
| Actual Calculation given for the Whole SWAP Agreement (In Thousands) | ||||||||
1993 |
1,994 | 1,995 | 1,996 | 1,997 | 1,998 | All Other | Total | |
| Receive Fixed Swaps | ||||||||
| Notional Amount | 2,436,000 | 9,096,000 | 8,880,000 | 1,050,000 | 90,000 | 46,000 | 917,000 | 22,515 |
| – | – | – | – | – | – | – | – | |
| Received | 184,649 | 545,760 | 474,192 | 63,210 | 6,516 | 2,861 | 62,447,700 | 63,724,888 |
| Payment | 79,901 | 298,349 | 286,824 | 35,280 | 2,916 | 1,467 | 32,462 | 737,199 |
| Net Amount | 104,748 | 247,411 | 187,368 | 27,930 | 3,600 | 1,394 | 62,415,238 | 62,987,689 |
| Pay Fixed Swaps | – | – | – | – | – | – | – | – |
| Notional Amount | 627,000 | 970,000 | 318,000 | 272,000 | 267,000 | 109,000 | 7,000 | 2,570,000 |
| – | – | – | – | – | – | – | – | |
| Received | 20,378 | 32,883 | 10,589 | 8,867 | 9,185 | 3,717 | 231,700 | 317,319 |
| Payment | 41,633 | 56,842 | 15,900 | 15,667 | 16,207 | 5,777 | 617 | 152,643 |
| Net Amount | (21,255) | (23,959) | (5,311) | (6,800) | (7,022) | (2,060) | 231,083 | 164,676 |
| Basis Swaps | – | – | – | – | – | – | – | – |
| Notional Amount | – | – | – | 2,200,000 | 1,600,000 | 16,000 | – | 3,816,000 |
| – | – | – | – | – | – | – | – | |
| Received | – | – | – | 70,840 | 52,320 | 512 | – | 123,672 |
| Payment | – | – | – | 73,260 | 53,440 | 768 | – | 127,468 |
| Net Amount | – | – | – | (2,420) | (1,120) | (256) | – | (3,796) |
| Forward-Starting* | – | – | – | – | – | – | – | – |
| Notional Amount | 500,000 | 100,000 | 6,720,000 | 1,500,000 | – | – | – | 8,820,000 |
| – | – | – | – | – | – | – | – | |
| Received | 36,000 | 5,740 | 334,656 | 85,200 | – | – | – | 461,596 |
| Payment | 16,900 | 3,380 | 227,136 | 50,700 | – | – | – | 298,116 |
| Net Amount | 19,100 | 2,360 | 107,520 | 34,500 | – | – | – | 163,480 |
| Closing Balance | 102,593 | 225,812 | 289,577 | 53,210 | (4,542) | (922) | 62,646,321 | 63,312,049 |
| Cumulative | 102,593 | 328,405 | 617,982 | 671,192 | 666,650 | 665,728 | 63,312,049 | 126,624,097 |
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