Banc One Corporation Asset and Liability Management Case Study Analysis
Question:1
Falling stock price
The main problem is the declining stock price of Banc One Corporation. The company has made heavy investments in the interest rate swap, resulting in an increased risk for the investors of the Banc. This increased risk has further resulted in a negative perceptions of the investors as this significant decrease has not just caused the company demand to plummet but has also played a major part in being a declining factor of the company’s stock price within a few months. Banc One's stock price dropped from $48 to $36 in November 1993, a 25% drop in just eight months. This drop in the stock price has a significant influence on Liberty National Bancorp's upcoming criminal charges. This share will continue to pay the share exchange; which might be paid with undervalued shares, or Banc One Corporation might have to delay the allegation.
Question:2
If Banc wants to reduce the interest rate exposure without using SWAPs, then it needs to match the maturity exposure to the interest rate of liability and assets in the balance sheet. By matching the duration of assets and liability; Benson Corporation can also manage the interest exposure without using SWAPs. If the assets of the organization are floating rate and liabilities are fixed, then it must be matched by using more floating liabilities to save itself from any distortion of performance to the floating rates change. IN this way, the bank can move from the assets-sensitive to mildly sensitive liabilities without using SWAPs, which would get the floating rate and will also pay the same amount that will reduce the floating rate risk by offsetting the receipt and payment of the same amount.
Question:3
Following are the pros and cons of both the options as matching the duration and amount of floating rate of both assets and liabilities and using swaps. One of the most significant benefit of using swap is that it helps in hedging the interest rate risk.It can also help in matching the assets and liabilities on the balance sheet of the bank, but it increases the risk for shareholder in case the bank heavily invests onswaps.On the other hand, it also decreases the liquidity of the Banc One Corporation,
because it is an illiquid asset, and the probability of default also increases.
Whereas, the matching duration of liabilities and assets also reduces the reinvestment risk for the firm and carries the potential to maintain an optimum level of funds.
For Banc One Corporation, it is easy to use swap option which is less time consuming. On the other hand, the matching duration of liabilities and assets is difficult to implement, which makes it an uneasy task. Swaps have positive impact on some financial ratios reported on the balance sheet, because these are off-balance sheet transaction of the bank, but in real, it has negative impact on the financial ratios of the bank.
The bank can mislead by falsely reporting and favorable ratios. Same can be done with capital ratios as current ratio of the bank favors the swaps, which looks favorable and highly improved to the shareholders and other investors. As the return on assets with swaps is 1.53%, which without swap is 1.06%.Return on equity is 17.89% with swaps, and it is 15.42% without swaps, so we can say that swaps overstate the financial ratios.
It is apparent that swaps have a significant impact on Banc One Corporation's interest rate sensitivity, for example: the net interest margin with swap is 6.22 percent, 4.58 percent with treasury, and 3.86 percent without any investment. Similarly, the net interest margin excluding the swaps is 5.52 percent, 4.58 percent with Treasury, and 3.86 percent without any investment. If Banc One Corporation employs swaps, the difference would be enormous.
Derivatives portfolio can affect the bank's asset and liquidity, and $200 million notional amount is such a large amount which has the higher potential to potentially damage the valuation, because if the interest rates are fixed against the variable interest rates and rates areon a decreasing trend. If this happens, then the bank would have an obligation to pay the fixed interest ratedespiteofits current interest rates being on a declining trend, affecting the company's profitability. This agreement will only be in effect for a limited time..............
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